How Often Do Options Get Exercised Early?

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In-the-money calls and puts often trade for less than their intrinsic value the difference between the stock price and strike price on, or near, expiration day. This is especially true for deep-in-the-money options. It also seems like once you get close to expiration day and there is very little time premium left in deep in-the-money options, the problem is even more prevalent. Let me give an example based on real-life situation I saw recently.

Many investors would accept this as normal and close their positions below the intrinsic value. After all, while options pricing theory may say that an option should not trade for less than its intrinsic value less any commissionsthings are rarely as neat in real life, right? There are ways that you can get the full value for your option position. But there is a better way, and it is based on options pricing theory.

Option theory is partially based on the idea of arbitrage, and it says that an option should not trade for less than intrinsic value. If it does, arbitrageurs would sell the stock and buy the call for a guaranteed profit. The buying and selling pressure would continue until the option price equals its intrinsic value. So how can you close an in-the-money option that is trading below parity? The same way the arbitrageurs would. Instead of selling your call at the bid, place an order how to close call option before expiration sell the stock.

Once that sell order has been executed, immediately exercise the call option. Once the sell order is executed you then submit your exercise instructions to your broker. It is possible that the commission charge from your broker may be slightly more to do it this way, but not necessarily. However, shorting the stock subjects you to unnecessary risk. You may hear objections about selling shares that are not in your account.

But the regulations certainly allow it although it is possible you have an individual broker that does not. In these days of Internet how to close call option before expiration, with most shares held by brokers in street name, it may be hard to remember back to when most investors kept stock certificates in a safe deposit box and often called in sell orders without the shares at the brokerage firm.

But how to close call option before expiration is perfectly acceptable to put in a sell order without the shares being physically at your brokerage firm as long as they are delivered within the settlement period. Even if your firm does require the shares to be in your account for you to sell them, just let your broker know that you will be immediately submitting exercise instructions to purchase the shares.

So once you sell the stock, immediately submit exercise instructions. It is important to submit your exercise instructions on the same day or the sale of stock and purchase from the option exercise will not settle on the same day. Closing Long Put Positions What if instead you are long put options? The way to capture this difference in the case of put options if they are trading below intrinsic value is to buy the stock and then exercise your puts. Again, any extra commissions you may have to pay will be well worth it.

Why do options sometimes trade below their intrinsic value? It usually is because the market makers are having difficulty laying off their risk. But it basically comes down how to close call option before expiration the law of supply and demand. There are simply more sellers than buyers. On or near expiration day, everybody wants to sell their calls, but nobody wants to buy them. The market maker is always willing to buy, of course, but he will naturally try to get as big a premium as he can get for providing that service.

The answer is that they are. The market makers are buying at the bid price and then selling the stock. However, there can be times where there is not enough volume or interest how to close call option before expiration bring prices into equilibrium.

If the market maker buys the call option from you and the stock continues to fall, they end up with a loss by the time they short the stock.

So they charge a premium to cover their risk while awaiting executions. What about arbitrageurs or retail investors? They can, but not only will they have commission costs, they have to purchase the call at the ask price and sell the stock at the bid price. With the wider spreads common with deep in-the-money options that leaves little or no room for error. When you notice large differences between the quoted price and intrinsic value, you may be tempted to think about trying to compete with the market makers.

After all, that looks like a lot of money just sitting there to be picked up for little or no risk. But I would not recommend it. Now you are the highest bidder. But there is a catch: How do I know that will happen?

Because you would how to close call option before expiration giving them a call option for 10 cents! Market makers love to buy deep in-the-money call below their fair value. For almost no risk, their worst possible outcome would be losing 10 cents. In other words, they would use your buy order as their guaranteed stop order. How to close call option before expiration meant the broker would sell the stock, covering the sale by exercising the call or to buy the stock and cover by exercising the put.

To get the best return you possibly can, it is important to understand how options work and the markets they trade in. And it also helps considerably if you have a broker that fully understands options and can execute your instructions properly. Len Yates is the President and founder how to close call option before expiration OptionVue Systems International and has earned worldwide recognition for his groundbreaking work in options analysis software.

He has published numerous books and articles on options analysis and trading strategies, and is a primary contributor for the educational site DiscoverOptions. At Connors Research, we are using it as an overlay to many of our best strategies to make them even better -- now you can, too. The Connors Group, Inc.

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Some beginning option traders think that any time you buy or sell options, you eventually have to trade the underlying stock. There are actually three things that can happen. Outcome 1 is actually the most frequent. The fact that option contracts can be opened or closed at any given point prior to expiration leads us to the mysterious and oft-misunderstood concept called open interest. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options.

Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point.

The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.

System response and access times may vary due to market conditions, system performance, and other factors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy.

The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between.

Calendar year Source: Meet the Greeks What is an Index Option?