Options Expiration Pricing

Topic: Yipes! Getting Close to Expiration.

Dear Options Trading FAQ:

If I hold an option, and it is getting close to expiration, what are my alternatives? Do all options that are in the money get exercised? That is, the day before my option expires (and it is in-the-money), who on earth would be willing to buy my option (unless they want to buy the shares, and then why wouldn't they just buy in the market)? It could be that I am completely missing something here, but can you explain exactly what happens in aggregate with open positions when options expire?

Confused on Option Expiration

Dear Confused Option Trader:

You can (and usually should) offset your long option position at any time by selling the contracts in the open market. As long as there is a bid quoted, your broker can execute the sale. Matching off the aggregate buy/sell, open/close option positions is one of the responsibilities of the Option Clearing Corp.
Most contracts are not ultimately exercised, but are rather offset in the open option market. Prior sellers need to buy to close and prior buyers (like you) need to sell to close their positions. The options that settle in or at the money get exercised/assigned. This entails actual purchases and sales of the underlying stock. Index options would be cash settled.

As for who would buy the option, there are a thousand and one reasons why someone would do it. Here's a dramatization of a famous and extreme example: It is 4:00 in New York on expiration day and Gerber has just closed for the day. Trader X hears something very interesting from a reliable source. He rushes to the phone to call his option broker, knowing that the Gerber call contracts trade until 4:10pm.

The broker takes Trader X's breathless order to buy 200 out-of-the-money options at the market. The order for a worthless, about to expire, option is strange, but the broker promptly executes it, knowing that Trader X has unusual sources of information. The contracts are bought for 1/16 and then expire, seemingly worthless. Trader X calls his broker to make sure the options are exercised. Puzzled but compliant, the brokerage house does so. The rest is history as the Gerber takeover is announced late Friday. The fat takeover premium gives Trader X a huge score. Not bad for a few minutes work and a $1,250 investment!

PS. Trader X is still dodging the SEC inquiry into the situation.
Best wishes and watch out for the federales!

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Expiration, Options Valuation, Options Pricing

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