Explore Your Options
| Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C. |
Tom Gentile of Optionetics |
EXPIRATION QUESTION
What happens if I hold my put option until expiration and forget to close it out? Is there anything I can do after the fact?
The short answer is that once expiration has passed, the contract no longer exists and there is nothing left to do. But keep in mind two things can happen to an open option contract at expiration: It expires worthless or it is subject to automatic exercise.
If an option has no intrinsic value at expiration, it will expire worthless and cease to exist. If XYZ is trading for $51 a share heading into January expiration, the XYZ January 50 put will have no intrinsic value and expire worthless. It is out-of-the-money (OTM). After all, why would someone pay for the right to sell or "put" XYZ for $50 a share, when it can be sold in the market for $51? A call option will expire worthless if the strike price of the option contract is greater than the stock price. In that case, the option holder has no need to buy or "call" the stock at the strike price of the option. It would be cheaper to buy the stock than through the exercise of the option contract.
So one scenario for the put option is that it is OTM, has no intrinsic value, and expires worthless. There is no point in exercising that option.
Options that do have intrinsic value will not expire worthless, even if the option holder forgets to exercise the contract. If the option is in-the-money (ITM), it will be subject to automatic exercise. The Options Clearing Corp. (OCC) has created a rule that states that all options with intrinsic value at expiration should be automatically exercised. The rule ensures that investors don't inadvertently leave money on the table when the option expires. If XYZ is trading for $49 a share at January expiration, the January 50 put will be exercised and for every put option, 100 shares will be sold at $50 even if the strategist has not requested that the option be exercised. If XYZ is trading for $51 a share, the XYZ 50 call will be exercised and 100 shares of XYZ will be bought at $50 a share for every call contract.
As of the October 2006 option expiration, the threshold for automatic exercise was lowered from 25 cents to a nickel. If the option contract is ITM by less than a nickel, it will expire worthless. But if the option is in-the-money by a nickel or more at expiration, it will be automatically exercised.
If the strategist doesn't want the option exercised, they can either close the position before expiration or send a request instructing the broker to not exercise the option. If this is important to you, ask your broker what needs to be done to avoid automatic exercise. The exact procedures may vary.
AFTER THE BELL
When does after-hours trading begin and when does it end?
Options do not trade after hours, but stocks trade on ECNs before and after the exchanges are open for normal trading. Right now, some brokers offer trading from 8:00 to 9:30 am and 4:00 to 6:00 pm Eastern time. Check with your broker to see if they offer after-hours trading and if so, what ECNs they send orders through.
Keep a few points in mind. ECNs simply match buyers and sellers and execution is not guaranteed. If there is no natural seller for a buy order, it will not get executed. Different prices can exist on competing ECNs. The after-hours market is less liquid than when the exchanges are open. The result can be greater volatility and bigger price moves in individual stocks. For that reason, it is better to place limit orders rather than market orders when looking to buy or sell shares when the exchanges are closed.
‘TIS THE SEASON
Do you use seasonality in your trading? If so, what is an example?
"Seasonality" refers to the fact that certain asset prices tend to rise or fall during certain times of the year. The strong period for stocks, for example, lasts from November to May, and that pattern has given rise to the saying "Sell in May, then go away." Seasonality is stronger in the commodities markets. Natural gas prices rise in the autumn ahead of the cold winter months. Many grains show strong seasonal patterns. Seasonality is important and interesting, but not enough to work with. It is best combined with other forms of technical and fundamental analysis.
A LITTLE CONFUSED
In your November 2006 STOCKS & COMMODITIES column, you state: "Say XYZ is trading for $50 a share and I buy the XYZ December 55 call for $2.50 a contract. Now suppose XYZ shares rally 10% to $55. In that case, the strategist has a profit of at least $2.50 a contract, which is equal to the current stock price ($55) minus the strike price (50) minus the cost of the trade $2.50..."
Assuming the first sentence is correct and does not contain a typo, the situation is a 55 call purchased for $2.50, the underlying then increases 10% to $55 a share. The position is now at-the-money.
You are correct. The November 2006 "Explore Your Options" contained
a typo. The strike price in this example is 50 and the first sentence should
have read, "December 50" call instead of "December 55." Thank you for being
an astute reader and bringing it to my attention.
Originally published in the January 2007 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 2006, Technical Analysis, Inc.
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