The two types of options are calls and puts.

A call option gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of call options are expecting that the stock price will increase substantially before the option expires.

A put option gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of put options are expecting that the price of the stock will fall before the option expires.

Buyers and Sellers in the Options Market

There are four types of participants in options markets depending on the position they take:

1. Buyers of calls
2. Sellers of calls
3. Buyers of puts
4. Sellers of puts

If you buy an option you are called the holder of the option and if you sell an option you are called the option writer.

If you are the buyers are said to have a long position, and if you are the seller you are said to have a short position.

There are important distinctions between option buyers and option sellers which affect the risk associated with the option contract. Here is a summary of those distinctions.

• Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights or let the contract expire without exercising their right.
• Call writers and put writers (sellers), however, are obligated to buy or sell if the holder exercises their option. This means that a seller may be required to make good on a promise to buy or sell.

If this seems confusing at first, it becomes more clear as you get into some concrete examples, which we do on other articles here.

Also, you need to understand that an option buyer has a known and manageable risk (the cost of the option contract plus brokerage commission is the entire risk). The potential gain by an option buyer is theoretically unlimited, but will always have some discreet value when the option is exercised.

Consider this simplistic example: You buy a call option on stock XYZ. As the holder of the option, you have the right to  buy 100 shares of XYZ stock on or before a set future date at $10 a share. At the time you buy the option, the XYZ stock is trading at $7 a share, so the writer is betting that the stock won’t go up by $3+ dollars by expiration. But let’s say the stock goes bonkers and climbs to $100 a share by expiration. You exercise your right and get to buy 100 shares of XYZ from the writer for $10 a share.

Where does that stock come from?

Well, the writer either has the stock in his portfolio (he wrote a covered call) or he doesn’t (he wrote a naked call). Either way he loses. If he owns the stock, he’s obligated to sell the stock that is worth $100 a share to you for $10 a share – so he loses out. If he had bought the stock earlier at a sub $10 price, he didn’t lose money on the stock , but since he could have otherwise sold it for $100, he lost out on the ability to cash in on that profit.

On the other hand, if the writer wrote a naked call, he could be in some serious cash-flow problems. You see, he now has to go out and buy the shares at market price ($100 per share, or $10,000 for one contract) and then turn around and sell those shares to you for $10 per share. In this case the writer is out a very real $9,000. Ouch.

So the potential risk of an option writer much higher than an option buyer.

You may be asking yourself at this point, “So why would anyone ever want to write options if it is so risky?”  Well, if you know what you are doing, you can make a lot of money by pricing your contracts in such a way that you have the advantage. The key phrase is that you have to know what you are doing, and you need to know it really well.

For this reason, option writing is a much more advanced and strategic topic, and it’s best to wait until you are an advanced options trading before you begin trading options as a seller. So if you are a beginning options trader, stick with buying options until you have more experience.

In fact, some very successful options investors are content to use managed strategies that never delve into options writing. But if you get really good at trading options, you may want to try your hand at writing options at some point. At this point, it is good enough to just understand that there are always two sides of an options contract.

Whenever you trade a stock option, you need to choose an expiration month. Since stock option trading strategies require making modifications during the life of an option, you need to know in what months the options will expire. Many beginning options traders don’t realize that the expiration month you choose has a significant impact on the potential success and profitability of any option trade. That’s why you need to understand how the various stock exchanges decide what expiration months are available for each stock. This article will give you the basics.

Historical Constraints on Stock Option Expiration Dates

At any given time, there are at least four different expiration months all available stock options.  Why four months? Well, when equity options first started trading in 1973, the Chicago Board Options Exchange (CBOE) decided there would be only four months in which an option could be traded at any given time. That’s why there are always at least four months available to choose from. But later on, the exchanges introduced long-term equity anticipation securities (LEAPS). Since then, it is possible now to trade options for more than four months.

Stocks Can Have Different Options Expiration Dates

You may have noticed that not all stocks have the same expiration months available. Let’s look at the expiration months available from September 2010 for three different stocks:

Microsoft (Nasdaq:MSFT), CitiGroup (NYSE:C) and Progressive (NYSE:PGR).

Microsoft: Sept 2010, Oct 2010, Jan 2011, April 2011, Jan 2012 and Jan 2013.
Progressive: Sept 2010, Oct 2010, Nov 2010 and Feb 2011.
CitiGroup: Sept 2010, Oct 2010, Dec 2010, Jan 2011, Mar 2011, Jan 2012 and Jan 2013.

Notice that all three stocks have September and October options available. Also note that Microsoft and CitiGroup have options available in January 2011, January 2012 and January 2013, while Progressive does not.

What might be confusing is that even though all three have the September and October expiry dates available, the third expiration date out is completely different for all three. A final puzzle piece is that CitiGroup has an extra trading month: March 2011.

Believe it or not, there is a reason for all these seemingly random dates. Let’s take a closer look at how the exchanges determine stock option expiration dates.

The answer starts again with an historical precedent. When stock options first began trading, each stock was assigned to one of three cycles: the January cycle, the February cycle or the March cycle. Each stock was assigned to one of these quarterly cycles on a purely random basis.

Stocks assigned to the January options cycle had option expirations available only in the first month of each quarter: January, April, July and October. Stocks assigned to the February cycle had only the middle months of each quarter available: February, May, August and November. Stocks on the March cycle had the last month of each quarter available: March, June, September and December.

The Modified Expiration Cycles

As options trading became more popular, floor traders as well as retail and individual investors wanted the option to trade or hedge for shorter terms. So the original rules were modified, and in 1990, the CBOE decided that every stock would always have the current month plus the following month available to trade. This is why all three of the stocks in the above example have September and October options available.

Remember we said earlier that every stock has at least four option trading expiration months. Under the new rules, the CBOE established that the first two months are always the two near months, but for the final two months, the original quarterly cycle rules apply.

It may help to look at an example. As I write this it is the beginning of January, so we’ll look at a stock assigned to the January options trading cycle. Under the newer rules,  January and February will be available as trading months since they are the current and next month out. To get the minimum of four availbe expiry dates, we apply the January rules for the next two dates, so we add the first month of quarter 2 and the first month of quarter three, which will be April and July. So, if I want to trade in this option, I can choose the expiration date of January, February, April or July.

When the January options expire, February is already trading, so that simply becomes the near-month contract. Because the first two months must trade options, March will begin to trade on the first trading day after the January expiration date. So the four months now available are February, March, April and July.

Once the February options expire, March becomes the current contract. The following month, April, has already been trading since January. So now we have March, April and July contracts trading, that’s only three expiration months, and we need four. So, we go back to the original cycle and add October because it is the next month in the January cycle after July. So, just after the February options expire, the March, April, July and October options will now be available.

You can apply the same formula when to determine option expiration months for stocks on the February and March quarterly cycles.

Adding LEAPS

If a stock has LEAPS available, then more than four expiration months will be available. Only the most popular stocks have LEAPS available. That is why in our example above, Microsoft and CitiGroup had LEAPS while Progressive did not.

Once you understand the basic option cycle, adding LEAPS is not difficult. LEAPS are long-term options that are generally no more than three years out and normally trade with a January expiration date. If a stock has LEAPS, then new LEAPS are issued in May, June or July depending on the cycle to which the stock is assigned.

When it is time to add (or go beyond) January in the normal rotation (not including the current or near-term contract), the January LEAPS that has been “hit” becomes a normal option, which also means the root symbol changes and a new LEAPS year is added. Once again, and example will make it easier to digest. Going back to our original examples, let’s walk through what happened to Microsoft and CitiGroup (the 2 stocks that had LEAPS).

For Microsoft we go back to May of 2010. The months available for Microsoft then were May 2010, June 2010, July 2010, October 2010, January 2011 and January 2012. Once the May options expired, another month needed to be added. The two front months, June and July, were already trading, as was the next month in the cycle: October. So, following the rules for the January cycle, we would need to add the January expiration month.

For a stock that did not have LEAPS, no further action would be necessary, and it would trade the four months of June, July, October and January 2011. But Microsoft already had LEAPS trading that expired in January 2011. So, instead those options were converted to standard options (with an accompanying symbol change), and January 2013 LEAPS were added.

Since Citigroup is on the March cycle, we need to jump ahead to the June expiration to see how it worked out. For the regular options, July, September and December were already trading, so all they needed to do was add the second front month: August. But for cycle-two stocks like CitiGroup the January 2009 LEAPS converted to standard options after the June expiration date, and the January 2013 LEAPS were introduced at the same time.

So, on the Monday after the June expiration, CitiGroup had options trading in July, August, September, December and January 2011, as well as LEAPS in January 2012 and January 2013. Cycle-three stocks follow the same procedure, whereby the 2011 LEAPS convert to regular options after the July expiration date, and the 2013 LEAPS are added.

How Can You Tell What Options Cycle a Stock Is On?

Since all stocks now must have options available on the first two months, you cannot tell what cycle a stock is on by looking at the front two months. To figure out the cycle, you need to look further out at the third and fourth listed months. You can usually tell from the third expiration month available. Just keep adding three months to the third month until you reach January, February or March. In our above example, CitiGroup has December as the third contract month, so if we add three months we arrive at March. We therefore know that CitiGroup is on the March cycle.

That said, you have to be careful if the third month out happens to be January. While that may indeed mean the stock is on the January cycle, any stock with LEAPS will also have January options trading. In that case, you need to look farther out to see what the fourth month is to confirm what cycle the stock is on. In the above example, Microsoft has April available, so we know for sure that it is on the January cycle.

Final thoughts

Stock option trading expiration cycles may seem a bit confusing at first, but once you understand the underlying rules, they aren’t that hard to figure out. And once you start to trade in stocks options a little more, expiration cycles will become second nature and you’ll compute them in your head at a glance.

If you are just learning about options, it may not see the importance of knowing these dates, but once you start to apply options strategies and need to make mid-contract adjustments to your options trade, you will see that it can be extremely important to know exactly what expiration months will become available in the future.

Understanding the expiration cycles is just one more weapon in your options trading arsenal that can increase your success rate when trading options.

The price of an option is called its premium. Remember that an options contract is for 100 shares. If the option price is set at $1, that is $1 per share. Buying a single option contract will cost you $1 x 100 shares $100. So the premium is $100.

When you buy option, you pay the premium up front and that becomes your total risk. You cannot lose more than the initial premium you paid for the option contract, no matter what happens to the underlying security.  The profit potential for an option holder (the buyer) is only restricted by how high the stock price can climb before the expiry date of the option.

The writer (or seller) of an option receives the premium up front. In return for the premium price received from the buyer,  the writer assumes the risk of having to sell (if a call option) or buy (if a put option) the shares of the stock at a price which could result in a loss to him. Unless an option is covered by another option or an actual position in the underlying stock, the option writer’s potential loss is open-ended. That means the seller can lose much more than the original premium received.

There are different strategies that option buyers and option sellers use to minimize risks and maximize profits. For strategy examples that are used when writing option contracts, see the examples on The Difference Between a Covered Call and a Naked Call Option.