1

Suppose a novice trader opens an online account with $5,000 with online trading platforms like e*trade, Ameritrade or Robinhood.

With the stock at $175, the trader buys 2 call options:

  • Option Price: $20
  • Strike Price: $200
  • Expiry: 6 Months from now
  • Cost: $4,000

On the last day of trading, the stock is $215 and the $200 call is in-the-money. The trader is not available to close the option. I assume that he now owns 200 shares of that stock which costs $40,000.

Questions:

  1. His account has only $5,000. What will happen if he does not have $40,000 to buy those stocks?
  2. Does a margin account allow him to buy the stock and then sell in a few days when he is available, realizing his profit?
  3. Do online brokers like e*trade or Ameritrade permit closing the option for whatever price a day before the expiration? I think this option can protect him from owning the stocks.
2

Two long calls at $20 per contract costs you $4k. That leaves you with $1k in your account.

If your calls are in-the-money at expiration and you do not close them, the OCC will auto exercise them and you will have to buy $40k worth of stock. If it's a cash account, you're lacking $39k. If it's a margin account (50%), you're lacking $19k.

Brokers anticipate this issue and how they handle it varies from broker to broker. They may:

  • Prohibit the exercise of the options

  • Close options if the effect of the exercise/assignment would be to place the account in margin deficit

You do not want the broker involved in these decisions. If the broker prohibits the exercise, you'll lose $3k of intrinsic value.

You have the ability to sell your call any time before expiration, avoiding these complications.

| improve this answer | |
1

I believe that if yours is not a margin account the calls would be settled in cash - you would see $3000 credited to your account. That's the only logical and reasonable course of action that any respectable broker would take.

But, if is unknown what the broker will do, it is best to sell the options slightly ahead of expiry and get the $3000.

| improve this answer | |

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.