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Precious metals investment terms A to Z

Expiration Date

Options’ and Futures’ D-Day.

Expiration Date is the date on which the futures or options contract expires. The option holder can elect to either exercise the option or allow it to expire worthless. The owner of the futures contract must settle accounts with the other party on the expiration date to either pay or receive the difference between the agreed upon strike price and the actual market price of the underlying asset.

Eric asks:

Eric, Jill and John are on a weekend trip outside the city. During their drive a terrible storm broke out. Luckily, they were able to get to the guest house, where they had made a reservation.

Prof. Jill, the Investor

Prof. Jill, the Investor

Guys, I’m really happy we made it. Another five minutes behind the wheel and I’d have gone insane.
John, the Trader

John, the Trader

Yup, it’s good to be here inside in warmth.
Prof. Jill, the Investor

Prof. Jill, the Investor

I’ll go and check us in.
Read the whole discussion

Definition

Expiration Date if the date on which the life of a derivative (e.g. a futures contract or an option) ends. For example, if you buy a gold futures contract DEC 11 (termination date: December 28th, 2011), this means that on December 28th, 2011 you will have to settle accounts with the other party to the contract. One party will pay the difference between the agreed price and the actual market price of gold and the other party will receive that difference. This settlement is obligatory.

On the other hand, if you buy a gold option, for instance SEP 11 (expiration date: September 27th, 2011), you will have the opportunity, but not the obligation, to settle accounts with the other party of the contract. (The main difference between options and futures lies in the obligations they put on their buyers and sellers. An option gives the buyer the right, but not the obligation to buy (or sell) a certain asset at a specific price at any time during the life of the contract. A futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date, unless the holder's position is closed prior to expiration.) So, with options if settlement meant that the option buyer would lose money, he does not have to settle accounts. He lets the option expire worthless and the premium he paid for the option is the maximum that he can lose. You can think of this like buying a movie ticket. You pay the ticket price and have the option to go to the cinema. However, if you change your mind the only thing you lose is the price of the ticket. it’s the same with an option – you may complete a deal or you may not; the only thing you lose is the price of the premium you paid for the option).

To summarize, on expiration date the parties settle accounts with each other (obligatory in the case of futures, optional in the case of options.) One party pays to the other party the difference between the initial value of the underlying asset and its value on the expiration date. The derivative instrument can be traded on the market until its expiration date (to put it simple: you may sell your futures or options if there is somebody who wants to buy them). You can find a list of precious metals futures grouped by termination date at Yahoo! Finance.

If you consider trading options, they need to realize that the price of options decreases as the expiration date gets nearer (in other words, if you're right, you've got to be right fast, or else you'll lose your money). This phenomenon is called time decay. The price of option falls because the closer to the expiration date the easier it is to predict what the actual price will be on the expiration date.

For example, let‘s say you buy a gold option on January 1st and the expiration date is September 27th. The current price of gold is $1300 and the price agreed on is $1500 ( the strike price). It is difficult to predict whether the actual price will hit the strike price, therefore the price of the option is relatively high. However, as time goes by, it is easier to make such a prediction. So, if on 25 September the market price is still $1300, it is a no brainer to predict that the price will not hit the strike price. (However, one cannot completely rule out such a possibility). Therefore, the price of the option is relatively low (it decays in time; you obviously wouldn’t want to buy such an option, neither would other traders and investors – that’s why the price is low).

It often happens that the underlying assets of the derivatives are traded in huge volumes near the expiration date. This is because entities owning derivatives want to influence the price of the underlying assets so that the derivatives would help them make profit. As this is pertinent to the precious metals market, it is extremely important for precious metals traders and investors to know the expiration dates and anticipate the downward/upward moves of metals and stocks (you wouldn’t want to miss the opportunity to make substantial profit or, avoid severe losses).

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