11

Options have recently sparked my curiosity as you can short a stock with a put option and only risk your premium (as opposed to shorting in a margin account) but I still have a few questions.

  1. Why do people rarely execute options and instead sell the contract? Is it because the options allow you to control a lot more shares than maybe you have capital to purchase?

  2. What if the contract expires in the money, and you haven't sold the contract, does it automatically execute the option to call or sell?

  3. Is it hard to find good opportunities when looking for options? The stocks I follow, it seemed the options listed were unrealistic, or, after factoring in the premium were hard to make substantial gains.

7

Why do people rarely execute options and instead sell the contract? Is it because the options allow you to control a lot more shares than maybe you have capital to purchase?

Yes. Spot on analysis.

What if the contract expires in the money, and you haven't sold the contract, does it automatically execute the option to call or sell?

Yes. Every broker has their own rules for this if you are right at the money. They typically just extend credit to you and you have a margin call and several business days to close the excessively large position.

If the position moves against you then you get excessively large losses.

Is it hard to find good opportunities when looking for options? The stocks I follow, it seemed the options listed were unrealistic, or, after factoring in the premium were hard to make substantial gains.

No. When you are right the gains outpace the gains of holding the stock/underlying directly. When you are right but your timing is wrong, or when you are wrong completely, then the losses are great too.

  • 6
    Please don’t use code tags for normal text. The fixed-width font and lack of wrapping make it hard to read; e.g. on my smartphone display, I need to scroll horizontally for each line. I believe screen reader users (e.g. blind people) are also impaired, because the software may try to spell out the words or similar. – chirlu Jan 18 '18 at 23:13
3

Why do people rarely execute options and instead sell the contract?

By this what is understand is after buying an option, why do most people not wait till contract expiry and instead sell it at [profit / loss] during the time the contract is valid.

Options are generally to mitigate the risk. However quite a few traders / investors take advantage of price movements during the options and encash the options by selling it rather than waiting till expiry. A new buyer of the option may choose to buy an option because he has underlying risk to mitigate or believes that option is right priced and he can make money.

What if the contract expires in the money, and you havent sold the contract, does it automatically execute the option to call or sell?

This depends on the exchange. Most leading exchanges automatically close [exercise] the "in money" options and credit the difference [between current price and option strike price] to the option holder. In most exchanges options are settled for cash rather than the underlying stock/security. So if you are looking at having a particular stock at the end of the expiry; you may have to buy it in open market.

Is it hard to find good opportunities when looking for options? The stocks i follow, it seemed the options listed were unrealistic, or, after factoring in the premium were hard to make substantial gains.

Options are to mitigate risk on a particular stock/securities in case the market becomes to volatile. Hence on normal market, there will be no opportunities to make money and that is reflected in the option price. It is to cover an unanticipated risk ... Hence more often the options expire out of money.

1

Why do people rarely execute options and instead sell the contract? Is it because the options allow you to control a lot more shares than maybe you have capital to purchase?

No - it's because options almost always are worth more than their intrinsic value, meaning the gain or loss that you'd realize by exercising them. Investors who buy options typically are just interested in gain or loss of the option itself to hedge the underlying instrument, and may not want to actually buy or sell the instrument, so they exit the position before it exercises.

Is it hard to find good opportunities when looking for options? The stocks I follow, it seemed the options listed were unrealistic, or, after factoring in the premium were hard to make substantial gains.

Then you're not looking at it correctly. Options are not a way to lock in certain gains (meaning it will cost you more in premium when buying an in-the-money call option than any future gain that you lock in) The goal of buying or selling options is to either mitigate price risk, in which case the value of the option is not as relevant, e.g. when buying a put option to guarantee a minimum price for an option after some period of time, or to get returns from the value (premium) of the option itself, so the "gain" should be measured relative to the original option premium, not to the value of the underlying stock.

I have toyed with options quite a bit (usually covered calls on stock that I already owned) and have learned that it is an interesting side-bet, but it does not mean certain victory, nor does it guarantee significant gains relative to the stock.

0

Why do people rarely execute options and instead sell the contract?

If there is any time premium remaining, selling the option rather than exercising it throws that time premium away. Assume that we're talking about a long call (it's the same for long puts except for the positions and direction). If you don't want to own the underlying then you will have more frictional costs by exercising the call and then having to sell the stock.

If the call is ITM and/or near expiration, it may trade for below parity (negative intrinsic value) and exercising it will avoid the haircut. For example, XYZ is $100 and you own a $95 call that is trading for $4.75 x $5.25. The intrinsic value of the call is $5. If you sell at the market, you lose 25 cents. You could place an order to sell at $4.95 and you might get lucky. or not. But what if XYZ drops $1 while you are waiting for a fill? Now tyour intrinsic value is only $4 and you have lost a $1 and you still have that illiquid option on your hands.

At $100, exercise the call to buy 100 shares at $95 and simultaneously sell the stock at $100. The gross is $500 (less commissions). I trade at IBKR so assignment and exercise are free so it's one commission either way I do it.

As for what happens if the contract expires in the money and you havent sold the contract contrary to another reply, it is automatically exercised.

“Exercise by Exception" is the Options Clearing Corporation provision for the automatic exercise of in-the-money options at expiration. They will automatically exercise any expiring EQUITY call or put that is $0.01 or more in-the-money. However, a specific brokerage firm’s threshold for such automatic exercise may or may not be the same as OCC’s. If you are long the option, you can designate to your broker that te OCC does not exercise your in-the-money option by any amount. The person who is short the option must close it prior to expiration to avoid this. INDEX options are settled in cash.

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.