Expiration Date (Derivatives)
Candlefocus EditorExpiration date for derivatives refers to the final day on which a derivative – a financial instrument that derives its value from an underlying asset – can be used. After this date, the contract is no longer valid, and those who own the derivative must take some action if they wish to retain its value.
The action taken depends on the type of derivative. Option owners have the choice to exercise their option and make a profit or loss, or to let it expire worthless. Owners of futures contracts may roll them over to a later date or choose to close their positions and take delivery of the underlying asset or commodity that is tied to the contract. Those who own swaps may make a similar decision, either rolling them over or closing them out.
No matter the type of derivative, the process involved in deriving a derivative's value and the resulting expiration date must be thoroughly investigated by both parties. It's important to ensure a derivative is accurately priced, especially at the expiration date, so that the correct costs and fees are accurately calculated and assigned. A mismatch in expiration dates could create an imbalance in the value of the contract that must be justified by associated charges.
In order to protect buyers and sellers, some countries have gone a step further and mandated that derivatives do not exceed a certain term. This prevents those who buy derivatives from being locked into the contract beyond a certain time period.
Understanding the expiration date of a derivative is key to evaluating the costs, risks, and gains involved in the contract. As expiration approaches, investors must decide whether to roll over their positions (if possible) or to exit the market. To ensure that their decisions are based on the best information available, buyers and sellers of derivatives should focus on the terms and conditions of the contract and the associated costs and risks. Doing so will help them determine when and how to act when the expiration date arrives.