Expiry Trading: Strategies, Risk and Opportunities in the Stock Market

Key Takeaways

• Expiry trading can generate quick profits due to sharp price movements, but the same volatility can lead to big losses if trades go in the opposite direction.

• Option premiums melt fast on expiry day. This benefits option sellers but is a concern for option buyers.

• Successful expiry trading in the stock market depends on a backtested strategy like breakout trading, option chain analysis, and strict risk management.

Expiry Trading: Introduction

Expiry day in the stock market is the day when futures and options contracts expire. Expiry trading refers to buying and selling these contracts on their last valid trading day.

In the Indian stock market, the benchmark indices of NSE and BSE are Nifty and Sensex, respectively. These indices are highly traded and attract significant volume on expiry days. Both Nifty and Sensex have weekly expiry as well as a monthly expiry cycle.

Nifty weekly options contracts expire every Tuesday, while monthly option contracts expire on the last Tuesday of each month.

On the other hand, Sensex weekly option contracts expire on every Thursday, and the monthly contract expires on the last Thursday of each month.

This article explains how to do expiry trading, along with strategies, benefits, risks involved and more.

What is Expiry Trading?

Expiry trading, or expiry day trading, involves buying and selling options contracts on the last valid day. On expiry days, the option premium prices are relatively low compared to other trading days because there is no time value left, and premiums are traded at their intrinsic value.

In short, on expiry days, the option premiums decay rapidly due to time decay. This creates unique opportunities for both buyers and sellers.

Additionally, volatility tends to increase, and market indices might show wild price swings.

Option buyers participate in expiry trading to take advantage of these wild price swings with relatively low capital. In contrast, option sellers aim to benefit from time decay, expecting the premium to expire worthless.

How to do Expiry Trading?

Expiry trading requires speed, discipline and a clear strategy. Here is a structured approach:

1) Identify the market trend:

To identify the market trend, monitor global news, track Gift Nifty ticks, observe market sentiment at the opening, and use indicators like VWAP and moving averages.

2) Focus on important levels:

Mark important support and resistance levels, identify demand and supply zones, and analyse call and put data in the options chain.

3) Choose Liquid Instruments to Trade:

Trade indices like Nifty, Banknifty and Sensex; as these instruments are highly liquid and easy to enter and exit.

4) Choose the Right Strike Price:

For buying options, select the At The Money (ATM) strike price to trade. However, if you are doing option selling, try to choose “Out of the Money” OTM options.

5) Use Strict Risk Management:

Always use a stop loss to limit potential losses. Avoid overleveraging and trade with a small position size that you are comfortable managing.

Expiry Trading Strategies

While doing expiry trading, option buyers and option sellers employ various trading strategies. Some of the most common strategies are as follows:

1) Momentum Breakout Strategy:

Traders make use of this strategy when a key support or resistance level is broken on either the upside or downside. Make sure to use volume to get confirmation of the breakout. This strategy is ideal for trading on the expiry days.

2) Range Breakout Strategy:

Traders apply this strategy when the price of indices or stocks breaks out of a defined range. It is often observed that when the price breaks either side of the range, it shows strong momentum. However, always use a tight stop loss to manage risk.

3) Option Chain Strategy:

Identify the strike price with the Highest Open Interest (OI) buildup in call and put data. The highest OI strike in the CALL option acts as a resistance, and the highest OI strike in the PUT option acts as a support.

4) VVAP Strategy:

If the price is trading above the VWAP, the intraday market chart structure is bullish, and the price may go upwards. On the other hand, if the price is below VVAP, the chart structure is bearish, and the price may go downwards.

Expiry Trading: Option Buying Strategy

On expiry trading, option buying is popular due to low premium cost and high reward potential.

Here is a common option buying strategy used by expiry traders:

Strategy: ATM Breakout Buying

In this strategy, you either buy an ATM Call option or a Put option.

Example:

In the first 30 minutes, Nifty is traded in a range between 24,000 and 24,100.

Here, 24,100 is acting as a resistance and 24,000 as support.

If the nifty breaks out of 24,100, you buy an ATM (24,100) Call Option. However, if Nifty broke down to 24,000, you would buy an ATM (24000) Put Option.

Advantages:

• On expiry day, you can buy an ATM call/put option at cheap price.
• High return potential.

Risk:

• Fast premium decay
• Wrong side prediction can lead to full capital loss.

Expiry Trading: Option Selling Strategy

On expiry trading, option-selling strategies benefit from the time decay. One of the common strategies used by option traders is the short strangle and short straddle.

Short Strangle: In this strategy, you sell both a call option and a put option of different strike prices. Here, you expect prices to trade in the range, so that theta decay works in your favour.

Example:

Nifty current price: 24,300.

In the chart, you can see 24000 as support and 24,600 as resistance.

Therefore, you choose to sell Nifty 24,000 PE and 24,600 CE. If the Nifty shows expiry inside the range, the premiums of both the strikes will become zero.

Short Straddle: In this strategy, you sell both a call option and a put option of the same strike price.

Example:

Nifty current price: 24,300

Nifty 24,300 CE trading at ₹46 Nifty 24, 300 PE trading at ₹40

You expect that Nifty is likely to show expiry near 24,300. That’s why you sold 24,300 CE and 24,300 PE.

How to trade Hero Zero on the expiry day?

Hero Zero trading is a high-risk option trading strategy. In this, you buy a deep OTM Call option at very low prices.

If the trade starts moving in your direction, the deep OTM options turn into ITM options, and you earn a huge profit.

Why is it called Hero Zero?

If the market moves sharply in your direction, your option becomes HERO. However, if your market stays in a range, then deep OTM options become worthless (Zero).

Benefits of Expiry Trading

Expiry trading offers several benefits, due to which a large number of participants come together to trade on the same day:

1) Quick Profit Opportunities:

On expiry days, big price moves are possible, which create opportunities for quick profit by scalping.

2) Low Capital Requirement:

Option buying requires relatively low capital, as premium prices are low compared to other trading days.

3) High Liquidity:

Nifty and Sensex options are very liquid. You can easily enter and exit the trade without any risk of a higher spread.

4) Weekly Opportunities:

Nifty and Sensex options have weekly expiries, providing opportunities to traders to trade with low capital and capitalise on short-term price movements.

Risk Involved in Expiry Trading

Expiry trading is not for everyone. Before placing a trade on expiry day, understanding the risk is crucial. Here are the major risks involved:

1) High Volatility:

Most of the expiry trading days are volatile; sudden reversals or breakouts can wipe out a big chunk of capital.

2) Theta Decay (Time Decay):

This works against the option buyer, if the market trades sideways and does not move quickly, your OTM options will lose value and eventually become zero.

3) Over-trading:

Frequent traders due to losses can lead to revenge trading/over trading. When you over-trade, you increase your chances of losing.

4) High Leverage:

Derivatives are high-leverage products; a small mistake can lead to big losses.

5) Gap Up or Gap Down Risk:

On expiry day, if the market opens with a gap up or down, it can significantly impact your overnight carry-forward positions.