What Are Monthly Options?
Monthly options are a type of options contract that expires on the third Friday of each calendar month. These standardized financial derivatives give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined strike price on or before a specified expiration date. As a prominent part of the derivatives market, monthly options are widely used by investors and traders for various purposes, including hedging and speculation.
History and Origin
The concept of standardized options, including those with monthly expiries, originated with the establishment of the Chicago Board Options Exchange (CBOE) in 1973. Prior to the CBOE, options were traded over-the-counter with non-standardized terms. The CBOE revolutionized the market by introducing uniform contract sizes, strike price intervals, and fixed expiration dates, making options trading more accessible and transparent. The CBOE, founded by the Chicago Board of Trade in 1973, was the first U.S. exchange to offer standardized, exchange-traded stock options.10, 11 This standardization laid the groundwork for the development of monthly options as a staple product in the options market, allowing for consistent trading cycles.8, 9
Key Takeaways
- Monthly options are standardized options contracts that expire on the third Friday of each month.
- They provide flexibility for investors to align strategies with monthly economic data releases or corporate earnings reports.
- Monthly options are commonly used for both speculative trading and managing risk through hedging strategies.
- The premium paid for a monthly option reflects its intrinsic value and time decay, among other factors.
Interpreting Monthly Options
Monthly options are interpreted based on their relationship to the underlying asset's price and the time remaining until expiration. For a call option, profitability generally increases if the underlying asset's price rises above the strike price, while a put option typically benefits from a decrease in the underlying's price below the strike price. The closer the expiration date, the more pronounced the effect of time decay on the option's value, which can be a significant factor for traders holding options near the end of their lifecycle. Investors monitor the volatility of the underlying asset and broader market sentiment to gauge potential movements that could impact the option's value.
Hypothetical Example
Consider an investor, Sarah, who believes that Company XYZ, currently trading at $100 per share, will experience a significant price increase after its earnings report, which is scheduled for the second week of next month. To capitalize on this potential move, Sarah decides to buy a monthly call option on Company XYZ with a strike price of $105, expiring on the third Friday of the upcoming month.
She pays a premium of $2 per share, or $200 for one standard 100-share options contract. If, after the earnings report, Company XYZ's stock price rises to $115 by the third Friday of the month, Sarah's call option would be "in the money." She could then exercise her right to buy 100 shares at $105 each and immediately sell them on the open market at $115, realizing a gross profit of $10 per share ($115 - $105). After accounting for the $2 premium paid, her net profit would be $8 per share, or $800 for the contract ($1000 gross profit - $200 premium). If, however, the stock price remains below $105, her option would expire worthless, and she would lose the $200 premium paid.
Practical Applications
Monthly options serve a variety of practical applications in financial markets. Traders frequently use them for short-to-medium term speculation on price movements of stocks, indexes, or other assets, aligning their strategies with anticipated monthly events such as economic data releases or corporate earnings calls. They are also integral to hedging existing portfolio positions against potential downside risk or to protect profits. For instance, an investor holding a large stock position might buy monthly put options to limit potential losses. The U.S. options market, including monthly options, is overseen by regulatory bodies such as the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) to ensure fair and orderly markets and protect investors.6, 7 Market volumes in options have seen significant increases, reflecting their growing utility for both retail and institutional investors in managing positions and expressing market views.3, 4, 5
Limitations and Criticisms
Despite their utility, monthly options carry inherent limitations and criticisms. One significant drawback is the accelerated time decay, particularly as the expiration date approaches. This means that options lose value simply due to the passage of time, requiring traders to be accurate not only in their directional forecast but also in their timing. The leverage offered by options, while a benefit, can also lead to substantial losses, potentially exceeding the initial premium paid, especially for sellers of uncovered options. The Financial Industry Regulatory Authority (FINRA) regularly highlights the risks associated with options trading, including the complexity of strategies and the potential for significant financial loss.1, 2 Furthermore, high volatility can impact option prices unexpectedly, making it challenging to predict outcomes.
Monthly Options vs. Weekly Options
The primary distinction between monthly options and weekly options lies in their expiration cycles. Monthly options expire on the third Friday of each month, offering a consistent and relatively longer-term trading horizon within a month. Weekly options, by contrast, expire every Friday (except for weeks where a monthly option expires), providing much shorter trading cycles. This difference in expiration frequency makes weekly options more susceptible to rapid time decay and more sensitive to immediate market movements, appealing to highly active traders seeking to capitalize on very short-term events. Monthly options tend to be favored for strategies that require a slightly longer time frame, such as trading around scheduled earnings announcements or economic reports that occur mid-month, or for position hedging over a few weeks. The increased frequency of expirations with weekly options can also lead to higher trading costs for active participants due to more frequent commissions and bid-ask spreads.
FAQs
How do monthly options differ from standard options?
Monthly options are standard options in the United States, typically referring to those that expire on the third Friday of the month. The term "standard options" often implicitly refers to these monthly contracts, distinguishing them from more recently introduced weekly or quarterly options.
Can monthly options be exercised before their expiration date?
Most monthly options on individual stocks and exchange-traded funds (ETFs) are American options, meaning they can be exercised at any time before or on their expiration date. Some index options, however, are European options and can only be exercised on the expiration date itself.
What happens if a monthly option expires "out of the money"?
If a monthly options contract expires "out of the money," meaning the underlying asset's price has not moved favorably beyond the strike price for a call option or below it for a put option, the option will expire worthless. The holder of the option will lose the entire premium paid for the contract.
Are monthly options suitable for long-term investing?
While options, including monthly options, can be used as part of long-term strategies like covered calls or protective puts, they are generally not considered long-term investments in themselves due to their finite expiration date and the impact of time decay. For direct long-term exposure to an asset, buying the asset itself is typically more suitable.