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Following the Three Ways to Buy Options article from NASDAQ, there are supposedly three different ways to trade options after buying them:

  1. Exercise the option at maturity
  2. Exercise the option before maturity
  3. Don't exercise the option

Specifically, the article's examples all describe situations in which a speculator exercises the option to buy the underlying and then sells those shares against the then-prevailing price. I've looked at other sources too and they also only mention these 3 specific methods.

Not having any prior experience with options, I was wondering why I can't simply trade the options themselves. Option prices move with the movement of the underlying so in theory I could simply trade the option itself without every needing (or wanting) to hold shares in the underlying asset. This is, of course, with the premise in mind that I trade before maturity.

As a simple example:

  1. I buy 1000 call options at a price of $ 3.00
  2. The underlying asset goes up and therefore the price of the call as well (e.g. to $3.10)
  3. I sell my 1000 call options for $3.10 and make a 1000x0.10 = $100 profit

In this simple example, I never actually buy or sell shares of the underlying. I am quite positive that this sort of option trading should be possible as my intuition would be that only the initial seller of the call (or put) option has an obligation to the final holder. Therefore trading options before maturity, purely as a leveraged product, should be possible.

Naturally, this sort of trading would entail a lot of risk but the article is making me doubt whether this is possible at all (mind you: no experience). So is this possible?

Adding to this: if I have a brokerage account of, let's say, $1000, am I allowed to buy $1000 worth of call options? Considering, herein, the fact that I am unable to actually buy that many shares of the underlying as that would be much more than $1000.

  • Only American style options can be exercised early. European style cannot and they are cash settled. – Bob Baerker 14 hours ago
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When you buy a call, you have the right, but not the obligation, to buy that stock at the strike price before expiration.

When you buy a put, you have the right, but not the obligation, to sell that stock at the strike price before expiration. This means you think the stock will drop in price.

You never need to exercise that right, and in fact, since there's almost always some time value as well as intrinsic value, you are better off selling the option than to exercise it. (Yes, there are exceptions. To capture a dividend, for example).

To directly answer the question as asked, you can buy and sell options without exercise and have the leverage you desire. Buying a call, for example, you are betting that you know better than the market, that a stock is sufficiently under priced so you will profit from the unexpected gain over that time.

To your comment-question most options are not exercised. Obviously, if out of the money, they are worthless at expiration. If in the money, the owner can still sell that option, avoiding the need to buy the stock. If not sold, most brokers will offer an exercise process. You need to contact the broker to understand their rules for automatic exercise. Options settle over the weekend. Buying (the stock) on Saturday, and having the company announce bad news on Sunday, can ruin your Monday.

In other words, to avoid the risk above, you should sell an in the money option Friday before the market closes.

  • That answers it for 99%. In the last sentence you state that "most options are not exercises, but sold close to or at expiration". To my knowledge, someone must end up with the option and so, in the end, must decide whether to let the option expire worthless or whether to exercise. Therefore, isn't that what happens with all options? – Jean-Paul Jun 12 '15 at 12:59
  • Yes. So basically you can sell the expired in-the-money contract to your respective broker which will then go ahead and profit from the actual underlying shares? – Jean-Paul Jun 12 '15 at 13:06
  • Added one more line. – JoeTaxpayer Jun 12 '15 at 13:16
  • @Jean-Paul It's not true that someone must end up with the option. Any option is a contract between a buyer and a seller. For example someone first must open-sell a call option. This can be a private individual or a market maker. This call is bought (open-buy) buy someone else. If this last person is closes his position by selling the option (close-sell) or the first person closes his position by buying back the option (close-buy) there will be one option less in the market. The number of options (open interest) fluctuate. – Karl Jun 12 '15 at 14:27
  • Not sure if I can recommend a book on options, but this one might help: amazon.com/The-Rookies-Guide-Options-Beginners/dp/193435404X – Karl Jun 12 '15 at 14:29
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"Not having any prior experience with options, I was wondering why I can't simply trade the options themselves. "

Yes, you can, and this is what everyone does. 70% of options on every part of the chain are closed before expiration.

You can look at the open interest and volume and see this phenomena.

There are massive amounts of leverage that you can create, but at this point the odds on table games have greater expected value than your leveraged options trades.

  • 1
    "Yes, you can, and this is what everyone does" - Actually, there is a big covered call fan base out there. So not quite everyone. "the odds on table games have greater expected value" - Options are zero sum, the 'house' is just the small commission, a tiny percent compared to the money put up. – JoeTaxpayer Jun 12 '15 at 14:35
  • @JoeTaxpayer there is a big "bull put spread" and "butterfly condor" fan base out there too. Retail traders selling covered calls really don't matter when you have one large participant trading the entire option chain up to OCC position size limits. Open interest and volume are all that matter. When volume is 30000 contracts and open interest is 200, most are just being traded and both parties have closed the contract before expiration. – CQM Jun 12 '15 at 15:34
  • @CQM - fair enough. Good points. – JoeTaxpayer Jun 12 '15 at 15:54
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It's possible, modulo the usual problem that leveraging amplifies your risk as much as your potential gain. Unless you have very deep pockets this is a dangerous game to play.

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    If you buy a call, your position is leveraged, to be sure, but you can't lose more than you put in. The stock goes down, even to zero, the option can only go to zero. Selling a naked put or call potentially has unlimited risk. – JoeTaxpayer Jun 11 '15 at 22:28
  • Joe: Plus losing the transaction costs, but admittedly there can be transaction costs buying/selling stock shares too. – keshlam Jun 11 '15 at 22:51
  • I updated the comment to clarify a bit. My comment was not meant as a complete answer but only in response to Keshlam's stating that one can lose more than they put in. – JoeTaxpayer Jun 12 '15 at 0:52
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    I agree with @JoeTaxpayer, Keshlam's answer is wrong. All you can lose with buying to open an option position is the initial premium and commission you pay. – user9822 Jun 12 '15 at 2:06
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    It is common practice to buy options and then sell them before expiry and your risk is actually limited to the premium you pay for the options. – Victor Jun 12 '15 at 12:12

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