What Happens to OTM Call Options on Expiry?

Have you ever wondered what happens to your out-of-the-money (OTM) call options when they reach expiry? It’s a common question among investors, especially those who are new to options trading. The answer is quite simple: OTM call options expire worthless. But, as with many things in the financial world, there's a lot more to it than just that.

What are OTM Call Options?

To understand what happens at expiry, let’s first clarify what it means for a call option to be “out of the money.” A call option gives the holder the right, but not the obligation, to buy a stock at a specific price, known as the strike price, before a certain date. If the stock price is lower than the strike price, the option is considered OTM because it wouldn’t make sense to exercise it — you’d be paying more for the stock than it’s worth.

Let’s break this down with an example:

Stock Price	Strike Price	Option Status
$50	$60	OTM
$60	$60	At The Money
$70	$60	In The Money

In this scenario, if you hold a call option with a $60 strike price, and the stock is trading at $50 at expiry, your option is OTM. This means the option has no intrinsic value, and exercising it would lead to a loss. Thus, it expires worthless.

The Expiry Process

At expiration, several things happen simultaneously. If your call option is OTM, the following sequence unfolds:

• The option is not exercised. Since there’s no profit to be made, neither you nor the buyer (if you sold the option) will want to execute the trade.
• You lose the premium. When you buy an option, you pay a premium to the seller. If your option expires worthless, that premium is lost.
• The position is closed automatically. The exchange or your broker will automatically close the position at the end of the trading day on the expiration date. You won’t need to take any action.

For OTM call options, this process happens seamlessly and automatically, often without the need for intervention on your part. It's one of the key reasons why options trading requires a strong understanding of the risk-reward dynamics, as the premiums paid on OTM options can add up quickly, particularly if you’re betting on unlikely price movements.

Psychological Impact on Traders

Now, let’s dive deeper into how OTM call option expiry impacts traders mentally.

When an OTM option expires, it’s essentially a confirmation that your expectations about the underlying asset's price movement were incorrect. This can lead to frustration, especially if you’ve consistently bet on OTM options. The emotional toll of repeatedly seeing options expire worthless can cause traders to question their strategy and overreact by making impulsive decisions in future trades.

A seasoned trader understands this risk and builds losses into their strategy. Instead of betting on improbable price moves, they balance their portfolio with a combination of safer, in-the-money (ITM) or at-the-money (ATM) options alongside riskier OTM options. This approach allows them to capitalize on smaller gains while still having exposure to larger potential payouts.

Why Do Traders Buy OTM Call Options?

If OTM call options expire worthless most of the time, why do traders still buy them?

The answer lies in their potential for outsized returns. Since OTM call options are cheap — the premium is lower than ITM or ATM options — they provide an opportunity for traders to gain exposure to massive price movements at a fraction of the cost. If the stock does rally and surpasses the strike price, the return on investment can be astronomical compared to what you’d make on an ITM option.

For example:

Stock Price	Strike Price	Premium	Return If Stock Hits $100
$80	$100	$1	$19 (1900% return)
$80	$80	$10	$10 (100% return)

The OTM call option in this example has a much higher potential upside, even though the chance of the stock reaching $100 might be slim. This high-risk, high-reward proposition is appealing to many traders.

Managing Risk When Buying OTM Call Options

Given the likelihood that an OTM call option will expire worthless, it’s important to manage risk effectively. Here are a few strategies:

• Limit the size of your OTM trades. Don’t put all your capital into OTM options. Instead, allocate only a small portion of your portfolio to these trades.
• Use OTM options as part of a broader strategy. Many successful traders use a combination of ITM, ATM, and OTM options to balance their portfolios.
• Set realistic expectations. Understand that most OTM options will expire worthless. This doesn’t mean your strategy is failing, but it does require patience and discipline.

Conclusion: The Key Takeaways

When it comes to OTM call options, the key takeaway is that they expire worthless if the stock price doesn't surpass the strike price by expiration. You lose the premium you paid, and the option is not exercised. However, the allure of significant potential returns keeps traders coming back to these high-risk bets.

Whether you choose to trade OTM options depends on your risk tolerance and overall trading strategy. If you can stomach the risk of losing your entire premium for the chance at a huge payout, then OTM options might be for you. But for most traders, a more balanced approach involving a mix of options types is the safest path to long-term success.