Expiry Trading Strategies (Expiry Strategy Backtest)

Last Updated on April 18, 2023

It’s a well-known fact that as options expiry day approaches, the biggest-cap stocks with actively traded options tend to witness huge trading volumes (and sometimes increased volatility). In fact, the most important day in stock trading is the expiry day. But what is expiry in options trading?

In options trading, an expiry time (or expiration time) is the time at which an options contract becomes void and can no longer be used. In the US, the options expiration date is the third Saturday of the expiration month, but the last day of trading is the business day (usually the Friday) preceding that expiration time. Because of the way it affects stock prices, options expiry trading day is a strategy for stock day traders.

Because of the increased volatility (see more below) any expire trading strategies might be worthwhile to explore. In this post, we take a look at expiry in options trading, at the end of the article, we present you several expiry options trading strategies that is backtested. There is no anecdotal evidence on this website!

What is expiry in options trading?

Options are financial derivative contracts that give the holder the right, but not an obligation, to buy or sell the underlying asset (say stocks) to the option writer at a specified strike price on or before expiry. At expiry, the contract becomes automatically useless, and the holder cannot exercise it.

The expiry time (or expiration time) is the time at which an options contract becomes void and can no longer be used. It is the time on the expiration day when the options contract ceases to exist. In the US, the options expiration date is the third Saturday of the expiration month, and the expiration time is 11:59 a.m. EST.

The expiration date and time should not be confused with the last day of trading in an options contract, which is usually the third Friday of the expiration month or the Thursday before it if the Friday is a public holiday. The expiration time is when the option actually expires, while the last day of trading is the deadline for the holder of the option to make their intentions to exercise the option known. Here is how the Nasdaq Exchange explains it:

The time of day by which all exercise notices must be received on the expiration date. Technically, the expiration time is currently 11:59 a.m. [Eastern Time] on the expiration date, but public holders of option contracts must indicate their desire to exercise no later than 5:30 p.m. [Eastern Time] on the business day preceding the expiration date.

What is options expiration week?

An option expiration week is the week of an options contract is to expire. It is the week that an options contract would expire. In the US market, stock options expire on the third Saturday of every month, but trading and exercising the options contract ceases on the Friday before that third Saturday of the month — except when Friday is a public holiday, in which case the expiration date becomes the trading day (Thursday) before that Friday.

So, the third week of the month is an options expiration week. During the expiration week, large-cap stocks with actively traded options tend to have substantially higher average weekly returns. This is referred to as the Options Expiration Week Effect (OPEX) or Options Week Anomaly/Seasonality.

When the options on stocks, stock index futures, and stock index options all expire on the same day, the expiration week is called a quad witching options expiration week. We witness this only four times per year — March, June, September, and December.

Options strategy builder

There are many strategies for trading options, but you may want to make use of an options strategy builder. The option strategy builder allows you to construct different options strategies and automate your trading.

Some of the options strategies you can use for expiration day trading include:

  • Selling a bear call credit spread (or a bear call spread) — you sell at an intraday top and profit if the underlying stock price drops.
  • Selling a bull call credit spread (or a bull call spread) at a possible intraday bottom — you’ll profit if the underlying stock price rises.

Another approach is to use a gamma-neutral strategy by using a combination of different options trades and buying/selling the appropriate amount to achieve a gamma-neutral position.

How do you develop an options strategy?

As with developing any other trading strategy, you would need some software to test different ideas and models.

However, the first step starts with doing some research to find models that could have an edge in the market. After creating different models, backtest them over a period of at least 15 years (or through different market cycles – both bull and bear markets) to see how they perform. Then choose the model that offers the best result and forward-test it to be sure it works in the current market situations. Some trading strategies work well in a bear market, while other work better in a bull market.

Expiry trading strategies (backtest)

Let’s go to backtest a few expiry trading strategies based on the options expiration week (with 100% quantifiable settings and trading rules). We use Amibroker for our backtests (please read here for why use Amibroker).

We won’t go into any specific option trading strategies. There are two reasons for that: First, options are complicated and not for retail traders at all, in our opinion. It’s much more difficult to make money in options than in stocks. Second, backtesting option strategies is also complicated and we currently don’t have the necessary data to do it. Thus, we focus on stocks and the world’s most important index (S&P 500- SPY) and the healthcare ETF with the tickercode XLV.

Expiry trading strategy backtest no 1

The first backtest of the day is the performance of S&P 500 (SPY) during the options expiration week.

Expiry trading strategies (backtest)
Expiry trading strategies (backtest)

The average gain is 0.3% per week and that is significantly higher than any random week.

If we break down the performance to each month we get the following table:

Expiry trading strategies by month
Expiry trading strategies by month

The first row, which starts with 4, is April and so forth. Only January and July are negative.

Let’s change the trading rules and backtest another twist of expiry trading strategies:

Expiry trading strategy backtest no 2

This time we backtest the healthcare ETF that has the ticker code XLV. Below is the equity curve of our trading strategy:

Expiry trading strategy (XLV)
Expiry trading strategy (XLV)

We won’t reveal the strategy because it was our monthly trading edge of September 2022 (see our single strategy no 24). But it’s a good example that you can find very profitable seasonal trading strategies.

The average gain is about 0.7% per trade, way above any random week.

Expiry trading strategy backtest no 3

We have another strategy that fits into our collection of expiry trading strategies: this time it’s the kingpin of trading – the S&P 500 (SPY). Here is the equity curve:

Expiry trading strategies
Expiry trading strategies

This is not similar to the one in XLV, quite the opposite. We don’t want to disclose the trading rules of the strategy but we can reveal that it’s what we call an overnight trading strategy. The average gain is 0.46%. Not bad for owning the stock market for only 24 hours!

The strategy was our monthly trading edge of May 2022 (see our single strategy no 20).

Expiry trading strategy backtest no 4: an expiry day trading strategy

We end the article by a backtest that is a short strategy that both enters and exits during the expiry day – a day trading strategy. This is how the equity curve looks like on SPY (read here for equity curve example):

Expiry trading strategy - day trading
Expiry trading strategy – day trading

There are 306 trades and the average gain per trade is 0.18% – more than enough to cover slippage and commissions. Considering this is a day trade we believe the numbers are pretty good!

Why might expiry trading strategies be profitable?

Short-term traders want volatility to prey on.

The media is fond of writing about the increased volatility on the Friday of the expiry day. Is it correct that expiry day has more volatility than other days?

Yes, it turns out that this is true. We did a backtest where we looked on the volatility on the expiration day, the quad expiration day, and any random trading day:

Volatility expiry day
Volatility expiry day

As you can see, expiry days seem to have slightly higher volatility than a normal trading day, especially the quad day four times per year.

Expiry trading strategies – ending remarks

We believe seasonality strategies, in general, are perhaps the most robust trading strategies there are and among the least likely to stop working (read here for why trading strategies stop working). This article provided you with a few expiry trading strategies that you can further develop on your own.

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