Selling my put contracts very deep in the money ?

scone

Newbie
2 0
This is a question for all the options experts out there. I am a beginner who is learning to trade options. I had a question regarding Deep-In-The Money options.

Suppose I am Long (bought) a put option for a stock priced at a strike price of $12 and lets assume the stock is currently trading at $11. Thus, my options as In-The-Money.

My goal is to sell to close the long puts at a higher premium. If the stock price goes down, the put premium would increase and I can profit from selling those options.

What if the stock suddenly gaps down to say $5 from $11 due to some bad news. When that happens, my options will be very Deep-In-The-Money.

The two questions I have is :
1) Since the put options will be very deep in the money, will there be anyone who will buy my put contracts. Will there be any volume at all at that strike price range ? Will I be stuck with the put options till the expiration ? I ask this because, i don't see a reason why another trader would buy my put options for such high premium and deep in the money.

2) What if I let those puts expire way deep in the money ? Scottrade, my broker, says the options will automatically get exercised. What does this mean ? Since buying puts means I have the right to sell the stock for the strike price, do I need to purchase the underlying stock at the gap down so Scottrade will automatically sell these stocks I bought at a higher price using my contracts.


Please excuse my weak knowledge on options as I am a beginner. Thanks for your time in advance !
 

forker

Senior member
2,688 500
The whole point of an option is that it's the option to exercise, not a requirement. Your broker is talking out their @ss as you can leave it to expire and only be out the premium. If however you signed a contract with them that has small print that states the option will be exercised, then you need to find a new broker. If I were you I would read the contract again.
 

scone

Newbie
2 0
Thanks forker. Sorry I did not mention that I do have the right to change that settings of automatic exercise. I am not worried about my broker, I am just trying to figure out how I can maximize my gain. From what I understand so far, if I want to sell the contract instead of exercising, the contract strike price will be way deep in the money with not much volume since not many would want to buy my contracts for high premiums ?

In this case, am I better of exercising the put contracts ? If so, I am confused how this works (Point 2 from above).
 

forker

Senior member
2,688 500
I am by no means very knowledgeable in options and there are a few guys on here that know more than me so I am not best placed to answer that question. Why are you trading options anyway? My understanding is that it was designed for businesses who want to hedge the risk of the future price of a product. For instance, and just a hypothetical example. You are a brewery and you want to buy apples for cider but there hasn't been much rain and you think the season is going to result in a small produce. To hedge your risk you pay the premium to buy apple options so that you can at least offset the inflated price if it turns out to be as you expect.

I don't know why anyone would want to trade options as a trading instrument. So if you don't mind me asking, why are you?
 

wackypete2

Legendary member
10,229 2,054
As far as I know all ITM equity and index options will get automatically exercised unless you notify the broker otherwise. The choice is still yours but you have to explicity state you don't want exercise.

Common options under most circumstaces can always be closed out by an opposing transaction however for deep ITM options you will not get the true value since the market maker is taking risk. The spread between buy/sell will be very wide.

If your option is exercised you will then be short the underlying stock. IT IS UP TO YOU TO THEN BUY BACK THE STOCK AT THE CURRENT PRICE OR KEEP YOUR SHORT POSITION. The broker will not make that decision for you unless you are under margined and get a margin call.

Peter
 

Windlesham1

Well-known member
443 35
Imagine all those who sold those puts,they will be happy to look big and pay up to close the position.
Very liquid stocks should not have huge spreads,check the open interest.
The trick is: not to be a forced buyer or seller, not just in options but in life in general!
 

MacroStyle

Junior member
11 1
Scone when you have a deep ITM option the best way to lock in profit is to delta hedge. In your example you would buy the stock at $5, when the option is exercised you realise $7 (if the option is ITM at expiry). If at expiry the option is OTM you can sell the hedge back at market price and still realise at least $7.
 
 
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