An option cycle, also known as an expiration cycle, refers to the set schedule of expiration dates that applies to different classes of options. Understanding option cycles is crucial for options traders and investors as it impacts trading strategy and potential returns. Here, we delve deeper into what an option cycle is, how it functions, and its significance in trading options.
What Is an Option Cycle?
An option cycle designates specific months when options are set to expire. Each newly listed option is randomly assigned to one of several established cycles to ensure a balanced distribution of options across different time frames. With few exceptions, particularly for options with monthly contracts, most equity options follow one of three primary cycles. These cycles determine when the option will expire if it is not exercised by the holder.
Key Takeaways
- An option cycle consists of the months during which a company's quarterly options expire.
- Most options are assigned to one of three specific cycles at the time of listing.
- Option volume and open interest tend to be higher for options expiring on the dates established by the option cycles.
How an Option Cycle Works
Option cycles are integrated across various options and futures markets and are regulated by authorities like the Securities and Exchange Commission (SEC). Investors typically explore available options based on option classes, which group together call and put options linked to the same underlying security. This categorization allows for organized navigation among available contracts.
Components of an Option Cycle
Options are divided into two primary categories: 1. Calls: Options that give the holder the right to buy the underlying asset at a predetermined price before expiration. 2. Puts: Options that provide the holder the right to sell the underlying asset at a predetermined price before expiration.
These options are also categorized by strike price and are sequenced by their expiration dates.
Option Cycle Assignments
Options are assigned to one of three primary cycles when they are initially listed. Historically, these cycles were based on four months, but a change in 1984 by regulatory bodies established that operations should include two front months followed by the next two months in the sequence. The three common option cycles are:
- JAJO: January, April, July, and October
- FMAN: February, May, August, and November
- MJSD: March, June, September, and December
Understanding the Cycles
- JAJO Cycle: The ends of each quarter (January, April, July, and October).
- FMAN Cycle: The middle months of each quarter (February, May, August, and November).
- MJSD Cycle: The last months of each quarter (March, June, September, and December).
This structuring affords investors opportunities to engage in trading or hedging for both short and long-term options.
Special Considerations
In contemporary trading, the importance of the cycle assignment has diminished for heavily traded stocks and index-tracking exchange-traded funds (ETFs). The introduction of weekly options allows traders to extend expiration dates by rolling quarterly options into any week throughout the year.
Monthly Progression in Option Cycles
Following the passage of time, an option cycle dynamically adjusts. Once a month elapses, the remaining two months continue on their original cycle, ensuring there are always two front months available for trading. For example, if February occurs, the availability will be February, March, April, and July; by June, it shifts to June, July, October, and January.
Expiration Time
All options categorized under standard cycles will expire at 4:00 PM Eastern Time on the third Friday of their designated expiration month, indicating a structured schedule within which traders must operate.
Less Common Expiration Cycles
While most options are structured around the three primary cycles, certain securities have contracts available every month. This is typical for securities that exhibit high liquidity, such as the S&P 500 and its correlated index funds. This liquidity makes them suitable for hedging, as they exhibit more stability, providing traders with numerous expiration date opportunities.
Additionally, Long Term Equity Anticipation Securities (LEAPS) offer an extended timeframe for investors. LEAPS are different from typical options due to their long expiration periods, occurring annually in January, at least one year from the date of purchase. They function like standard options but provide a broader horizon for strategic investment.
Conclusion
Understanding option cycles is crucial for any serious options trader. Since these cycles essentially govern the lifecycle of the options you may trade, grasping their functioning can immensely impact trading performance and portfolio management. The flexibility presented by weekly options, coupled with the structural nature of quarterly expirations, means that traders have various strategic opportunities, allowing for tailored investment strategies in the evolving landscape of options trading. By mastering the details of option cycles, investors can make informed decisions and leverage these financial instruments effectively.