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Options University’s Options 101 - Part 39

Filed Under Beginner Options Trading 

Options 101
Part 39
Jan FebMar                  AprMay Jun               Jul Aug Sep                   Oct Nov Dec 
 
When April expires, June will be added to the list since we must always have the current month and the following month available:
 
Jan FebMar                  Apr MayJun                Jul Aug Sep                   Oct Nov Dec  
 
When May expires, we will only have the following three contracts traded: June, July, and October. This means we must add a fourth. However, by default, we have June and July contracts traded (the current month and following month):
 
Jan FebMar                  Apr May Jun                 Jul Aug Sep                   Oct Nov Dec 
 
This means we must add the next quarterly contract. October is the next quarterly contract, but it is already traded, so we must move to the next quarterly month, which is January:
Jan FebMar                  Apr May Jun                 Jul Aug Sep                   Oct Nov Dec 
 
So the January contracts will start trading once May expires.
 
Leaps
As options gained in popularity, investors showed an interest in choosing from contracts that included longer times to expiration. In 1990, the CBOE answered by creating LEAPS. While the name makes them sound complicated, they are simply options but with longer lives. LEAPS is a registered trademark of the Chicago Board Options Exchange and stands for Long-term Equity AnticiPation Securities (as if that wasn’t obvious) and have expiration dates nearly three years in length.
 
When options first started trading, they were available for up to nine months in the future. But with the addition of LEAPS, you can find options nearly three years forward. If a stock has LEAPS options traded, there will be more than four contracts listed at any given time. So while your local newspaper or other sources may only print three expiration months to conserve space, understand that there are always at least four different contract months traded at any given time.
 
How do option cycles work with the addition of LEAPS? Once you understand the basic option cycle, adding LEAPS into the rotation is not too difficult.
 
As mentioned earlier, LEAPS usually trade in January for a maximum of three years forward although there are exceptions. If a stock trades LEAPS, then new LEAPS will be issued sometime between May and July. This is difficult to explain without the use of examples so let’s go back to our Intel options.
 
It is currently July ’05 and Intel has the following months trading: July, August, October, January ’06, January ’07, and January ’08 as shown by the “Xs” in the table below:
 
Jan
Feb
Mar
 
Apr
May
Jun
 
Jul
Aug
Sep
 
Oct
Nov
Dec
X’06
 
 
 
 
 
 
 
X
X
 
 
X
 
 
X’07
 
 
 
 
 
 
 
 
 
 
 
 
 
 
X’08
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
At this point, January ’07 and January ’08 are LEAPS contracts. The January ’06 is considered a quarterly contract since it is less than nine months until expiration.                                         
 
When July expires, September will be added. We will then have August, September, October, and January ’06, thus providing four months of regular contracts (nine months or less):
 
When August expires, we will have September, October, January ’06 thus providing only three different months of regular contracts:
 
At this point, the next January cycle month will be added, which is April:
 
This process continues and eventually the date will become May ’06. The January ’06 options will have been expired for four months and we will have the following months traded (Notice that the January ’06 options are no longer listed):
 
When May options expire, we will only have three contracts in existence (not counting the LEAPS January options). These months will be June, July, and October. This is where we need to add another January contract since it is the next January cycle month. It is at this point where the January ’09 contract will be rolled out:
At the same time, the January ’07 contracts will lose their LEAPS designation because they have less than nine months to expiration. The root symbol will change to show that it is no longer a LEAPS option. If you are holding this option, the symbol will automatically change in your account and there is nothing that you need to do. Just be aware that this can happen as some investors are puzzled when there is a symbol change on some of their LEAPS. This will happen in May, June, or July when the current year LEAPS option becomes a regular option. This process is called melding. Melding is when LEAPS options become regular options. Technically speaking, LEAPS options do not expire; instead, they meld to a regular option and then it is the regular option that expires.
 
So, depending on which cycle your stock is on, look for new LEAPS to be added sometime in late May, June or July.
 
 
Which Cycle Is My Stock On?
As mentioned earlier, there will be times when you will need to know when a particular month will be added to the list. Before you can find out, you will need to know on which cycle your stock is traded. This is easy to find out once you understand the expiration cycles. For example, let’s see if we can figure out which cycle Intel is on. It is now July and Intel has the following months being traded:
 
  • July
  • August
  • October
  • January ‘06
  • January ‘07
  • January ‘08
 
From what we learned earlier, we know there must be a July and August contract and we see that there is. You can never tell which cycle a particular stock is on just by looking at the first two months, since all options will have these months being traded. But we can find out which cycle the stock is on by looking at the third month and fourth months. The reason we cannot just look at the third month is that it may be January and we would not be sure if it is a LEAPS contract or not. In this case, the third month is October:
Now we just need to ask which cycle October falls under? It is part of the January cycle (it is the first month or the “January “position of the fourth quarter). So we just figured out that Intel trades on a January cycle.
 
Let’s try another. Which cycle is Dell Computer on? It is still July and Dell has the following contracts traded:
 
  • July
  • August
  • November
  • January ‘06
  • February ‘06
  • January ‘07
  • January ‘08
 
Once again, we know that the current and following month must be traded for all stocks so the first two months tell us nothing about which cycle the stock is on. However, the third month is November and that does reveal the cycle. Because that month is November, we know that Dell Computer trades on a February cycle (because November is the middle month or “February” position of the fourth quarter).
 
Let’s try one more example but this time we’ll show why you cannot consider January if it falls in the third month. We’ll still use Dell Computer but now assume that the July options have expired. If so, we’d see the following contracts traded:
 
  • August
  • November
  • January ‘06
  • February ‘06
  • January ‘07
  • January ‘08
 
We know to not look at the first two month of August and November since all stocks will have those months listed. However, in this instance, if we look at the third month, we’d find January and we’d be led to believe that Dell is on a January cycle. Remember, all stocks that have LEAPS options will have them listed in January so we cannot be sure if this is a January cycle stock or not. To be sure, we’d need to move down to the fourth month, which is February and now we know that Dell is on a February cycle. In order to find which cycle your stock is on, you can never do so by looking at the first two expiration months. All stocks have those months traded. You must find the next quarterly contract (with the exception of January) that is listed and that will guide you to the cycle on which your stock is traded. Once you know which cycle your stock is on, it never changes. You will always be able to determine which months will be traded and which will be added at expiration.
 
To be continued,,,

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