expiration effect

Expiration Effect

The rapid trading of a futures or option contract immediately before expiration. The expiration effect can cause large and rapid changes in the price of the contract, and usually is the result of traders seeking to close their positions to fulfill their various investment strategies before expiration.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

expiration effect

The effect on securities, options, and futures prices and volume as traders unwind their positions shortly before expiration of the options and futures contracts. Trading near the expiration dates often produces a flurry of activity and large price changes.
What should individual investors know about expiration effect?

Investors can cushion themselves from the expiration effect by adjusting their stock trading strategies to accommodate the volatility that can occur on expiration days. The major market moves triggered on these days can cause problems for investors who enter market orders at the open or close. This is especially true when buying or selling the blue chip stocks that make up the major indexes and therefore reflect the most volatility. Limit orders can help investors protect themselves and even profit from expiration day volatility. A limit order indicates the maximum price at which an investor will buy a stock or the minimum price at which he or she will sell it. That order will be executed only if the stock reaches the specified price. An investor who expects the stock price to fall on expiration day could enter a limit order to buy the stock at a lower price. An investor who expects the stock price to rise on expiration day could enter a limit order to sell the stock if it moves higher than its original price. If the stock reaches the limit order price, the broker will execute the order. If the stock doesn't reach the price set by the investor, the limit order won't be executed and the investor will retain his or her original position.

Henry Nothnagel, Senior Vice President—Options, Wachovia Securities, Inc., Chicago, IL
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.
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Not surprisingly, regulators around the world have responded with a number of measures aimed at reducing price volatility on account of the so-called expiration effect of equity derivatives.
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