I sold some call options for $2.55 premium at strike price of $130. At expiration, the market price was $130.55. I thought the option was not deep in the money and at a loss of $2, hence I didn't buy to close.

On Monday, I found out the option was adjusted and I lost all of my stocks.

Question is:

  1. Why do people exercise call options at a loss?
  2. Should I always buy to close at expiration?
  • 28
    To be clear, when you say "lost all of my stocks", you mean "received $130 per share for my stocks", right? – nanoman Mar 24 at 0:04
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    What do you mean by “the option was adjusted”? Do you mean “... exercised”? – Lawrence Mar 24 at 7:57
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    For those that don't know the difference, the owner has the option to exercise a long option. The seller is assigned. – Bob Baerker Mar 24 at 15:28
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    Did you consider in your numbers that 'one' option typically is for 100 shares? So exercising them got someone 55$, not 55 cent. – Aganju Mar 25 at 0:55
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    Really bad idea to play with options if you don't understand what happened to you man – C Bauer Mar 25 at 17:00

The price at which you sold the option, or at which someone else bought it, has no bearing on exercise. Someone holding a long option to expiration will exercise it if it's in the money, which this one was.

The person exercising it was likely not the same person who bought it from you at $2.55, but even if it was, the fact that they had a loss is irrelevant. They gained $0.55 by exercising versus letting it expire unexercised. Or if you prefer, they had the choice between a loss of $2.55 and a loss of $2.00. Of course they exercised. The purchase price of the option was a sunk cost for them.

If you are holding a covered call close to expiration and do not want your stock to be assigned, then yes, you should buy to close. Even if the call is out of the money, it can be a good idea to buy for $0.01 or $0.05 just to eliminate risk.

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    "The price at which you sold the option, or at which someone else bought it" I think you should say "premium" rather than "price", to avoid confusion with the strike price (which seems to be the core of the OP's confusion). – Acccumulation Mar 24 at 18:02
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    A classic sunk cost fallacy. – user3819867 Mar 25 at 12:06

You do not understand the fundamentals of options. This option assignment and loss of your stock is the result of that. With all due respect, get a good options book and spend some time with it.

An in-the-money has intrinsic value. At expiration it is the price of the stock less the strike price. IOW, your call was worth 55 cents. Not exercising meant that the owner would have thrown $55 dollars away per contract.

You have made the assumption that the original buyer still holds the call that you sold. While it's possible that your short calls were the only calls traded in the existence of this option, the probability of that is infinitesimal. In reality, your calls could have been bought and sold many times over with some of the subsequent owners making money and others losing.

In the US, if any option is one cent or more in-the-money at expiration, the Option Clearing Corp (OCC) will automatically exercise it whether it is long or short. This is called Exercise by Exception. For equity options, you will end up with a long or short position in the underlying (index options are cash settled). If you are long the option, you can designate to the OCC via your broker that it is not auto exercised at expiration. This would make sense if it is ITM by pennies and your commission and/or fees to close the position exceeds the ITM amount.

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A major principle of decision-making is that one should compare an option to other options you currently have. Much angst and suboptimal behavior is caused by people instead making their decisions based on comparing an option they have to an option they don't have (just in case it's not clear, I mean "option" as in "a possible course of action", not "stock option").

Suppose there's a new phone coming out that you're interested in. The only places that will be selling it are Website A and Website B. Website A says that if you pay a $2.55 reservation fee now, you'll be able to buy it for an additional $130. Website B says that they haven't decided what price to sell it for yet; they'll let you know when it comes out. $132.55 sounds like a great deal to you, so you pay the reservation fee to Website A.

Now the phone comes out, and Website B says they're selling the phone for $130.55. Which website should you buy it from? Getting it from Website A means paying a $2.55 reservation plus a $130 purchase price, for a total expenditure of $132.55, which is more than what Website B is asking for. So it appears that Website B is a better option.

However, that's comparing "pay the reservation fee and then pay the purchase price for Website A" to "don't pay anything to Website A and buy it from Website B". But that's not an option that's available to you anymore. You've already paid the reservation fee. It's what's known as a "sunk cost": it's a loss that you've already incurred, and is not affected by any future choices.

The reservation fee is lost regardless of which website you buy it from. If you buy the phone from Website B, the total amount of money the phone will cost you is $133.10. So given your current options, Website A is the best choice.

When your buyer bought the call from you, they paid a $2.55 premium, or "reservation fee", for the right to buy the stock for $130. The total cost of buying the stock using the call is $132.55, which is higher that the cost of just buying the stock on the exchange. However, just buying the stock on the exchange is not an option for them. Their options are to lose the $2.55 and pay $130 to exercise the call, or to lose the $2.55 and pay $130.55 to buy from the exchange.

The $2.55 is lost either case. One doesn't get one's money back if one doesn't exercise the option. If one did, there would be no point in selling options.

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  • "So it appears that Website A is a better option." you probably wanted to say "B is a better option" or "A is a worse option". – CodesInChaos Mar 24 at 20:32
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    This is the most complex and convoluted answer that I have ever seen, attempting to explain intrinsic value. It's simply the underlying price minus strike price for calls and strike price minus underlying price for puts (for options that are in-the-money). – Bob Baerker Mar 24 at 22:23
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    @BobBaerker If "underlying price minus strike price" were to explain it for OP, I don't think they would have asked their question in the first place. – Acccumulation Mar 25 at 0:25
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    @BobBaerker Actually, I think the explanation is quite clever. It avoids all the technical jargon and gets the point across quite clearly with a very relatable example. – AxiomaticNexus Mar 26 at 17:02
  • @AxiomaticNexus - If you're going to utilize options, you need to understand ultra basic concepts like Intrinsic value and you need to be able to do simple math. IOW, If A is greater than B then all you need to know is how to subtract number B from number A. If you need such a complex explanation to understand that then options are definitely not for you. – Bob Baerker Mar 26 at 17:41

Usually people call at loss because they expect to make a gain when the value of the stock goes down...

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