How does taking profits from a CALL option contract work?

Question

From the question you can probably tell I have not traded options before. My question is essentially this scenario. Lets say I buy an CALL options contract for a certain stock, probably for 100 shares, and the price rises substantially. Lets also suppose that I do not have the capital to actually buy 100 shares of this stock even if the price rises (take AMZN for example, that would be incredibly expensive). If that stock rises in value such that buying the 100 shares at the original strike price and then selling would make me money, can you realize that profit without actually buying the shares on margin? Is there an "auto buy/sell" option, pardon the pun?

Answer 1

If you buy a call option on an option exchange then you can sell it on an option exchange in order to close the position, never having owned the stock.

Here's a learning moment for later on:

If the stock that you bought a call on does very well and your call appreciates and goes deep in-the-money (ITM), it will most likely trade below parity (less than its intrinsic value) if the call is approaching expiration. That means that you will not be able to sell your call for the full value. But you can avoid this haircut:

Suppose XYZ is $110 and you own the Jan $100 call which is quoted at $9.80 x $10.20. The intrinsic value is $10 but the best bid is $9.80. That's a 20 cent haircut and if you accept $9.80. If you do, the counter party will do a discount arbitrage and nab the full $10.

You could attempt price improvement by trying to sell your call at $9.90 or $9.95 but there's little incentive for anyone to give you anything near intrinsic value, particularly with illiquid options. 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 $110 and immediately exercise your call to acquire the shares for $100 for a net $10 (less whatever you paid for the call). Short the stock first to avoid leg out risk (it locks in the $10). This can also done with long puts except that in that situation, you buy the stock first.

Apart from a margin account and approval to short stocks in your account, all you need to be able to do this is enough cash and/or marginable securities to meet the 50% margin requirement. You will not be charged any or borrow fees for shorting the stock since it is not an overnight trade.

Answer 2

There will always be a time premium.

Say you have a $100 strike, and stock at $110. As long as there is any time left to expiration, the option will be worth more than $10. Worst case, you will the in-the-money value less 5 cents. Traders would be happy to snap up an option priced at less than that value. It's not as if a guy is sitting at a computer thinking about making this potential $5. Computers are looking to see if these trades exist, and grabbing them in milliseconds.

If you are new to options, I suggest you study for a long time before putting up money. And paper trade for at least a year. Last, don't bet what you can't afford to lose. Yes, I said 'bet', as a simple call option is a bet, not an investment. There are many, many, ways to trade options, with different risk/reward. It's these numbers that will help you understand the difference.