4

Assuming American Options

Can you buy a stock option and immediately exercise it - or are you only formally given control of the option at the end of the trading day? Would you be able to sell it immediately just minutes (or seconds) after purchasing it?

A more detailed question,

What would be the inherent delay in doing a trade such as:

  1. buying a put
  2. buying the underlying
  3. exercising the put to sell the underlying

This trade is dependent on completing all 3 parts within a few seconds at most, depending on the situation. Certainly, the parts cannot be completed several minutes apart or have to wait overnight.

Sorry if this question is basic, I'm just reading about options, not trading yet.

6

You can, but it is easier just to throw your money away. The process you describe can never result in profit, as the option is priced according to the underlying security and the risk.

Of course, something relevant can happen 3 milliseconds after you successfully buy the option, and there is a profit (or loss) possible. But even then, selling the option back normally is a better deal than executing it.

For the second part of your question: you are not getting whatever security or option you buy immediately; there is a two-day settlement period. But you can sell it right away anyway (unless your broker doesn't support it), because what you sell you also only have to supply in two days.

3

You can exercise an American option at any time, including immediately after you buy it. However, in if there is any time premium remaining in the option, it would make no sense to do so because you are throwing away time premium that could be salvaged by selling the option to close (unless the time premium is less than your closing costs).

Exercising a put when you own the stock or exercising a call when you are short the stock immediately closes both legs at once.

Here's a learning moment for later on:

It does makes sense to exercise a long ITM option whose bid is less than parity, when you don't have a position in the underlying. This avoids the haircut.

Suppose XYZ is $40 and you own the in-the-money Nov $35 call whose B/A quote is $4.80 x $5.20. The intrinsic value of the call is $5 but the best bid is $4.80. That's a 20 cent haircut and if you accept $4.80, the buyer can do a discount arbitrage to close it for $5.00 (more on that in a moment).

You could attempt price improvement by trying to sell at $4.90 or $4.95 but there's little incentive for anyone to give you anything near intrinsic value. And while waiting for a possible trade fill, the price of XYZ could drop and you'd lose some of your call's gain. What to do? Do the discount arbitrage yourself.

Short the stock at $40 and immediately exercise your call to acquire the shares for $35 for a net $5 (less whatever you paid for the call). Short the stock first to avoid leg out risk (it locks in the $5). This is also done with long puts except that you buy the stock first.

  • I assume if you only have a cash account to have to exercise the call first, then immediately sell the stock? – Michael Oct 25 at 23:47
  • You cannot be short or use margin in a cash account. In the case of a long ITM call trading below parity, yes, you would exercise the call and sell the stock immediately. Set up both orders before executing the first one. IT may save you 5-10 seconds thereby diminishing price change risk. The only fly in the ointment would be a broker who has a delay in providing notification of exercise and/or notification of acquisition of the underlying. I don't know if this occurs at any other brokers - at mine, it's instantaneous. – Bob Baerker Oct 26 at 0:15

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