Exercising of "In The Money Options"

[ducati998]

I wanted this to actually be a "POLL", but anyway,the question is;

If you owned a June Expiration PUT OPTION that was deep in the money, how quickly would you exercise it, assuming that you had purchased the Option as "insurance" for a decline in the underlying stock, that you HOLD.

Example;

Current Stock Price......$47.57
Option Strike Price.......$50.00

Intrinsic Value...............$2.43
Time Value....................$1.37..........as of today.

cheers d998

 

[roguetrader]

Why would you exercise it since it has time value if you wanted to release the capital or felt the position was at risk you would be better just selling it

 

[ducati998]

duplicated the post somehow

 

[ducati998]

A valid point, and I shall rephrase the question, as if you were simply trading the options, I agree, you would simply close your position, and that would be via a MM, and you wouldn't hold any underlying to PUT anyway.

However, if you had bought a "PUT OPTION" as "Portfolio Insurance" and you held in addition to the PUT, the underlying stock, would you "PUT" the stock, to close out at a profit, or would you hold the stock in anticipation of a recovery, as, you could always repurchase the stock at a lower price if you wished to reinstate the position.Therefore, to my mind, you should be exercised almost immediately.

However, assuming that you held the underlying stock, and the PUT Option, with a wasting asset, ( Time Value ) would you exercise, or play the intrinsic value against the time value, as you may have sold CALLS and wish to retain the underlying, for whatever reason.

cheers d998

 

[britkid]

D998

I am not sure of the reason for your question as you seem to answering it for yourself, but I will throw in my two penny worth.

I assume your trading US stocks and options. It may have been an easier decision if you had supplied the name of the stock and the strike price of your PUT and what you paid for it.

Personally I would be looking back at the initial objective of why you bought the stock and what your profit objectives and where you would have placed a stop if you had not bought the PUT. If the stock has broken through the support level and appears to be heading down strongly I would get out regardless. You may want to sell the stock and hold the put for a touch longer but as time decay will be kicking in much faster as the PUT gets closer to the expiration date you would have to keep an eye on the stock and work out the what potential downside there is before it reaches the next level of support.

If I had sold calls on the position, I would buy them back if necessary, but if they are already well out of the money I would consider leaving them. I really find it difficult to justify holding a stock which is declining in price beyond support for what ever reason. As you said if you like it that much just buy it back when it has finished the retracement.

Regards

 

[roguetrader]

As I've only ever traded options "naked" as it wer, it is difficult for me to answer any further, I am assuming exercising a put forces the writer to buy the underlying at the strike price. If that is the case then you would lose the time value, surely selling both stock and options at this point in time is preferable to exercise.
The contract you have described is worth apprx $3.80 on the market (time +intrinsic) the stock is worth $47.57, sold seperately total of $51.37 If you exercise you get a return of $50
If you have sold calls against that, it is all getting way too complicated for me, option strategies such as that require all the information to make decisions, ie prices paid for and gained from the options, is the call in or out of the money, volatility of the underlying, if you excercised the puts you would have a naked call position with over a month to go. With that sort of time value remaining I suspect that is a stock capable of moving a fair bit

 

[ducati998]

britkid, Rogue

Thanks for your replies,
The reason for the question is twofold.
First off, there is a statistic knocking around that states 90% of Option buyers lose, and therefore, 90% of Option sellers win.

If this stat. holds any water, then, by selling, the strategy should have as a starting point a positive expectancy, prior to any analysis.

Now, as Rogue pointed out, traders will trade the Options, they "may" not hold the underlying stock. When an Option is exercised it is randomly assigned to an Option seller, who is obligated to then buy the stock at the strike price, and in my example that would have been $50

So my question is..................
If you held the underlying stock, and had purchased at $51, and as insurance had "bought" a PUT at $50, for a 2month duration, ie. Expiry is June 29, and the stock was currently trading at $47.57.............would you exercise the Option?

Scenario #2
On the surface this seems like a stupid question, but hear me out.
If I SOLD you a PUT at strike $50, and you currently HELD NO UNDERLYING, you would presumably buy the OPTION, and then purchase the underlying at $47.57, and EXERCISE me at $50............thereby locking in a 100% guaranteed PROFIT.............or as Rogue has pointed out, would you sell to the MM, and allow him to exercise for the profit? If selling to the MM, how LONG IN TIME would you allow your analysis leeway for the trade to work?

The question really is to do with the "TIME VALUE" and speed of decay, as opposed to holding for an even larger potential profit, by letting the stock price fall further.

The problem being that, the underlying can move in your favour, but the speed of time decay can erode your profit faster than your profit can accrue.

Obviously, if the underlying starts to rally and appreciate, then your profit is eroding on two fronts. So, hence the POLL. If I sold you a 100% guaranteed profit today, a deep in the money option;

Would you sell, or exercise immediately?
Or, would you play the time value?

If you choose to play the TIME VALUE, this tells me that the TIME VALUE component must be analysed differently.
If immediately, then TIME VALUE has been sold, and exercised at "Fair value" as far as the market is concerned. And this is the question I am seeking an answer to.

cheers d998

 

[Silent.Trader]

If I understand it correctly your question is how to get out of your position. Basicly you see three options.
1) excercise the put and deliver the stock.
2) sell the option and sell the stock seperately
3) sell the options and keep the stock for a new incline

In my book option 3 is completely different from the first two. Option three would be suitable if you decide that the bottom is reached and you're willing to accept the risk of the unprotected stock position.

The choice between option 1 and 2 depends imho on prices, expenses and risk. If there's significant timevalue option 2 is the way to go. If there's little to no timevalue the choice depends on the amount of commisions you have to pay and the volatility of the asset. If the asset is highly volatile you risk significant slippage when you choose to sell stock and option seperately.

Whether you should close out immediately or wait is purely a matter of marketvision. IMHO if you lost faith in the stock you should close out asap to prevent time decay. If you have still faith in the position you can hold, choose option 3 or roll your optionposition in such as way that you lock in (part of) the gain on the option and sit out the dip.

 

[Profitaker]

.
First off, there is a statistic knocking around that states 90% of Option buyers lose, and therefore, 90% of Option sellers win.

If this stat. holds any water, then, by selling, the strategy should have as a starting point a positive expectancy, prior to any analysis.

I wish !

Options get exercised and are closed prior to expiry. I can't remember where I seen the statistic, but only something like 30% of options actually expire worthless. If option writers did start from a "positive expectancy" then investors and institutions alike would hop on the band wagon and push option prices (implied volatility) down to such a level so as there was no longer a "positive expectancy" to the writer. And this would make perfect sense in an efficient market.

I recently read a book called "The Options Edge" By Gallacher (out of print now), and in the book he researched whether or not there was any naturally in built advantage to writing options, as opposed to buying them. The researched focussed purely on this question and not any particular market, indeed to he researched stock, indices, commodities and financial options markets. The data he used is also published in the book. He concludes that there is NO inbuild advantage to writing, rather than buying, options.

I'm inclined to agree with him.

 

[ducati998]

So, if your Option was, or became "In the money" you would exercise or sell it.
No-one in their right mind I take it would allow a profit to expire worthless due to non-exercise.

So the question remains,...............if you had an "In the money" option, with "time value" would you...................

( a ) exercise immediately, or,
( b ) play for further profit utilising the time value, and if so, how long would you allow, as, time value decreases every day, and in addition, you start moving out of the money.

cheers d998

 

[Profitaker]

ducati

My comments above were slightly off topic, but I think slightly relevant all the same. Getting back on topic...

You don't exercise an option if there is ANY time value remaining. There maybe some exceptions for example if a dividend is in play, but generally one tries not to give away money.

If I wanted to exit a profitable long option position I'd sell it. The only time I'd allow a long option to be exercised is if the option is a cash settled index option, and the long option is being used to lock other positons.

 

[A Dashing Blade]

. . .
So the question remains,...............if you had an "In the money" option, with "time value" would you...................

( a ) exercise immediately, or,
( b ) play for further profit utilising the time value, and if so, how long would you allow, as, time value decreases every day, and in addition, you start moving out of the money.

. . .

( a ) no
( b ) not quite sure what you mean

what about
( c ) sell it in the market?

 

[Profitaker]

Sorry off topic but...

Here are the definative stats as to what gets exercised and what expires worthless;

http://www.cboe.com/LearnCenter/cboeeducation/Course_01_03/mod_03_02.aspx

True it's just one exchange, but I very much doubt other exchanges are significantly different.

 

[ducati998]

Profitaker,
Thanks for the link with the stats, that is exactly what I was wanting to find out.
cheers d998

 

[roguetrader]

So, if your Option was, or became "In the money" you would exercise or sell it.
No-one in their right mind I take it would allow a profit to expire worthless due to non-exercise.

So the question remains,...............if you had an "In the money" option, with "time value" would you...................

( a ) exercise immediately, or,
( b ) play for further profit utilising the time value, and if so, how long would you allow, as, time value decreases every day, and in addition, you start moving out of the money.

cheers d998

D998, the question for me is a "How long is a piece of string?" question. Compare it to this one.
I am long a stock, from $42.50, it is currently trading at $45.70 should I sell it or hold it for further gains?
Now as you look at that question you should be thinkiing, that's pretty near impossible to answer without a lot more information, ie; what is the stock?, what sector is it in?, how long did it take it to make that move? Was that move in that time period normal? Where is it's current price in relation to previous price?

There are very few instances where an option should be exercised with any significant time value remaining, in such a situation you are simply giving away the time value. Lets try making the position a bit more real...............Let's say the position is for 1000 shares and is covered by 10 contracts. To exercise now you will give away $1370
To my mind the only part of the question I coud answer is a resounding no to exercising this option now.
Another way to look at it would be if you were to sell the options to me for $2.43 and sell the stock at market, you would now be in the same position as having exercised. I will then offer out the options at $3.80........good deal?

 

[ducati998]

Rogue,

Compare it to this one. I am long a stock, from $42.50, it is currently trading at $45.70 should I sell it or hold it for further gains?

Slightly different in that the Stock will not lose market value due to the length of time ( for practical purposes ) as will the option.

Therefore, for arguments sake your stoploss on the position is $41.00, and should it drop below you take a loss.

With the Option example, you are "In the money" by $50 - $47 = $3......+time value of lets say $2
You now have 2 variables to manage.
1........the actual strike price, and fluctuations of price around the strike, altering "intrinsic value"
2.......time value, wasting away every day that you hold.

The management of the price fluctuations should be straight forward.
What I was trying to get a handle on was, in %terms, how are time value stops executed?

Restated, "How much time value will you use, prior to closing out the trade"
The problem is of course that the PRICE can be moving in your direction, but TIME VALUE is wasting faster.............if PRICE of the underlying is moving against you, then both INTRINSIC & TIME are causing losses.

As opposed to the Option that has a high INTRINSIC VALUE, and a low TIME VALUE, these you would expect to be exercised on, as the profit is in the underlying, not in the Option.


cheers d998

 

[roguetrader]

The point I was trying to make with the stock example is that it is very difficultto arbitrarily comment without knowing what it is exactly you are talking about. Presented with the same question I certainly would not seek to suggest either where the stop loss should sit or whether the profit should be booked or not.

Back to the option question I still feel options with sgnificant time value should not be exercised unless one is in the habit of giving away money.
In the situation you have described the options were most probably bought as a hedge and are doing their job the priority of the decision lies with the underlying. Your analysis of it and what you intend to do with it will determine the most appropriate course of action for the option position

 

[ducati998]

Rogue,
And that is really all I was trying to clarify. If you had significant TIME VALUE in the Option, how hard are you going to hang on to it.

It would seem, as long as is feasibly possible, which of course is common sense.
Therefore, calling market direction with an in the money option, is as important as calling market direction in any strategy.

cheers d998

 

[roguetrader]

Therefore, calling market direction with an in the money option, is as important as calling market direction in any strategy.

cheers d998

Without a doubt, either in, out, or at the money. What you actually do by taking on an option contract is to add a new dimension, time, not only do you have to be right about the direction but also the time period in which it will happen.