The decision on stock option to trade based on your expectations for the underlying stock requires choosing an expiration month.  And what expiration month you choose will have a significant impact on the potential success of any option trade.  So it is important to understand how the exchanges decide what expiration months are available for each stock.

There are at least four different expiration months available for every optionable stock.  The reason for that is because when equity options first started trading in 1973, the Chicago Board Options Exchange (CBOE) decided there would only be four months of options traded at any given time.  Later, when LEAPS (Long Term Equity Anticipation Securities) were introduced, it was possible for more than four months to be traded.

Not all Stocks Trade the Same Options

You may have noticed that not all stocks have the same expiration months available.  We are coming up to the September expiration date so let’s look at the expiration months that are currently available for three different stocks: Microsoft (Symbol: MSFT), CitiGroup (Symbol: C), and Progressive (Symbol: PGR).

• Microsoft – Sept, Oct, Jan ’04, April ‘04, Jan ‘05, and Jan ‘06
• Progressive – Sept, Oct, Nov, and Feb 
• CitiGroup – Sept, Oct, Dec, Jan ’04, Mar ‘04, Jan ‘05, and Jan ‘06

The first thing you may notice is that all three have September and October options available.  Next, both Microsoft and CitiGroup have options available in January 2004, January 2005, and January 2006, while Progressive does not.  But then it gets more confusing.  For the third month out, not one of the months matches those for any of the other two.  And CitiGroup has an extra month trading, March 2004.  Exactly how do the exchanges decide what expiration months should be available for each stock?

To answer that question you need to understand the history of how the exchanges have managed the option expiration cycles.  When stock options first began trading, each stock was assigned to one of three cycles: January, February, or March.  There is no meaning as to which cycle a stock was assigned.  It was purely random.

A January cycle meant that options would be traded on the first month of each quarter.  So stocks assigned to the January cycle had options available only in the first month of each quarter: January, April, July, and October.  Stocks assigned to the February cycle only had the middle months of each quarter available: February, May, August, and November.  And stocks on the March cycle were had the end-months of each quarter available: March, June, September, and December.

The Modified Expiration Cycles

As options gained in popularity, it soon became apparent that both the floor-traders and individual investors preferred to trade or hedge for shorter terms.  So the original rules were modified, and the CBOE decided that every stock would always have the current month plus the following month available to trade.  That is why all three of the stocks in the above example have September and October options available. 

As I mentioned in the beginning, every stock has at least four expiration months trading.  The first two months, under the new rules, are always the two near months.   But for the two farther-out months, the rules use the original cycles.

Since this may seem a little confusing, it may help to look at an example.  Let’s say it is the beginning of January, and we are looking at a stock assigned to the January cycle.  Under the new rules there is always the current month plus the following month available, so January and February will be available.  Because four months must trade, the next two months from the original cycle would be April and July.  So the stock will have options available in January, February, April, and July.

What happens when January expires?  February is already trading, so that simply becomes the near month contract.  Since the following month must also trade, on the first trading day after the January expiration date, options for March will begin to trade.  So now we have February, March, April, and July available.  Now comes the tricky part.

Once the February options expire, March becomes the current contract.  The following month, April, is already trading.  But with 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 the March, April, July, and October options will now be available.  The same reasoning is used to decide what months will trade for stocks on the February and March cycles.

Adding LEAPS

If a stock has LEAPS available, then more than four expiration months will be available.  Not all stocks have LEAPS available, only the most popular ones, and only about ten percent of stocks have LEAPS available.  That is why in our example above, Microsoft and CitiGroup had them but Progressive did not. 

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

When it is time to add (or go beyond) January in the normal rotation (not including as 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.  This may seem confusing, so let’s go back and look at our original examples and walk through what happened to Microsoft and CitiGroup.

For Microsoft we go back to May of this year.  The months available for Microsoft then were May, June, July, October, Jan ’04, and Jan ’05.  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 May, June, Oct, and Jan ’04.  But Microsoft already had LEAPS trading that expire in January 2004.  So instead those were converted to standard options (with an accompanying symbol change), and January 2006 LEAPS were added. 

Nothing out of the ordinary happened to CitiGroup when the May options expired, since it is on the February cycle.  June was already trading, so all that needed to be done was to add the month of July.  So after the May expiration, CitiGroup now traded the months of June, July, September, and December, plus LEAPS in January 2004 and 2005.

But let’s follow through what happens after the June expiration.  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 2 stocks like CitiGroup the January 2004 LEAPS converted to standard options after the June expiration date, and the January 2006 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 2004, as well as LEAPS in January 2005 and January 2006.  Cycle 3 stocks follow the same procedure, with the 2004 LEAPS converting to regular options after the July expiration date, and the 2006 LEAPS added.

How Can You Tell What Cycle a Stock Is On?

You cannot tell what cycle a stock is on by looking at the front two months; all stocks will have those months available.  To figure out the cycle, you need to look further out at the third and fourth 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.  CitiGroup has December as the next contract month available.  Since December is part of the March cycle, we then know CitiGroup is on the March cycle.

But 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 the January options trading as well.  In that case you need to look further out and 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. 

Option expiration cycles for stocks may seem a bit confusing, but if you take a little time to understand them they become second nature.  It can be very important to know what expiration months will become available in the future.  Many option strategies require you to make adjustments during the life of a trade, and you need to be certain the contracts you will need are going to be available.  Understanding the expiration cycles is just one more way to help you increase your success rate when trading options.