Option trading: High dollar value stock option and equity exposure

Question

Probably an elementary question on options: If I trade options of a high dollar value stock, I will be exposed to higher equity as 1 option = 100 shares. Is there a way to reduce equity exposure? Example - if I sell 1 GOOGL ($850 a share) put option then I may end up buying about $85,000 worth of stocks.

Answer 1

Seems like you are concerned with something called assignment risk. It's an inherent risk of selling options: you are giving somebody the right, but not the obligation, to sell to you 100 shares of GOOGL.

Option buyers pay a premium to have that right - the extrinsic value. When they exercise the option, the option immediately disappears. Together with it, all the extrinsic value disappears.

So, the lower the extrinsic value, the higher the assignment risk. Usually, option contracts that are very close to expiration (let's say, around 2 to 3 weeks to expiration or less) have significantly lower extrinsic value than longer option contracts. Also, generally speaking, the deeper ITM an option contract is, the lower extrinsic value it will have.

So, to reduce assignment risk, I usually close out my option positions 1-2 weeks before expiration, especially the contracts that are deep in the money.

edit: to make sure this is clear, based on a comment I've just seen on your question. To "close out an options position", you just have to create the "opposite" trade. So, if you sell a Put, you close that by buying back that exact same put. Just like stock: if you buy stock, you have a position; you close that position by selling the exact same stock, in the exact same amount. That's a very common thing to do with options. A post in Tradeking's forums, very old post, but with an interesting piece of data from the OCC, states that 35% of the options expire worthless, and 48% are bought or sold before expiration to close the position - only 17% of the contracts are actually exercised! (http://community.tradeking.com/members/optionsguy/blogs/11260-what-percentage-of-options-get-exercised)

A few other things to keep in mind:

• certain stocks have "mini options contracts", that would correspond to a lot of 10 shares of stock. These contracts are usually not very liquid, though, so you might not get great prices when opening/closing positions

• you said in a comment, "I cannot use this strategy to buy stocks like GOOGL"; if the reason is because 100*GOOGL is too much to fit in your buying power, that's a pretty big risk - the assignment could result in a margin call!

• if margin call is not really your concern, but your concern is more like the risk of holding 100 shares of GOOGL, you can help manage that by buying some lower strike Puts (that have smaller absolute delta than your Put), or selling some calls against your short put. Both strategies, while very different, will effectively reduce your delta exposure. You'd get 100 deltas from the 100 shares of GOOGL, but you'd get some negative deltas by holding the lower strike Put, or by writing the higher strike Call. So as the stock moves around, your account value would move less than the exposure equivalent to 100 shares of stock.

Answer 2

You're forgetting the fundamental issue, that you never have to actually exercise the options you buy. You can either sell them to someone else or, if they're out of the money, let them expire and take the loss.

It isn't uncommon at all for people to buy both a put and call option (this is a "straddle" when the strike price of both the put and call are the same).

From Investopedia.com:

A straddle is an options strategy in which the investor holds a position in both a call and put with the same strike price and expiration date, paying both premiums. This strategy allows the investor to make a profit regardless of whether the price of the security goes up or down, assuming the stock price changes somewhat significantly. Read more: Straddle http://www.investopedia.com/terms/s/straddle.asp#ixzz4ZYytV0pT