37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
Gapter 1: Definitions 19
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cised but were not. If XYZ closed at 51 and a customer who owned a January 45 call
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option failed to either sell or exercise it, it is automatically exercised. Since it is worth
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$600, this customer stands to receive a substantial amount of money back, even after
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stock commissions.
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In the case of an XYZ January 50 call option, the automatic exercise procedure
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is not as clear-cut with the stock at 51. Though the OCC wants to exercise the call
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automatically, it cannot identify a specific owner. It knows only that one or more XYZ
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January calls are still open on the long side. When the OCC checks with the broker
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age firm, it may find that the firm does not wish to have the XYZ January 50 call exer
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cised automatically, because the customer would lose money on the exercise after
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incurring stock commissions. Yet the OCC must attempt to automatically exercise
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any in-the-money calls, because the holder may have overlooked a long position.
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When the public customer sells a call in the secondary market on the last day of
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trading, the buyer on the other side of the trade is very likely a market-maker. Thus,
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when trading stops, much of the open interest in in-the-money calls held long
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belongs to market-makers. Since they can profitably exercise even for an eighth of a
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point, they do so. Hence, the writer may receive an assignment notice even if the
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stock has been only slightly above the strike price on the last trading day before expi
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ration.
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Any writer who wishes to avoid an assignment notice should always buy back ( or
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cover) the option if it appears the stock will be above the strike at expiration. The
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probabilities of assignment are extremely high if the option expires in-the-money.
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Early Exercise Due to Discount. When options are exercised prior to
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expiration, this is called early, or premature, exercise. The writer can usually
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expect an early exercise when the call is trading at or below parity. A parity or
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discount situation in advance of expiration may mean that an early exercise is
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forthcoming, even if the discount is slight. A writer who does not want to deliv
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er stock should buy back the option prior to expiration if the option is apparently
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going to trade at a discount to parity. The reason is that arbitrageurs (floor
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traders or member firm traders who pay only minimal commissions) can take
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advantage of discount situations. (Arbitrage is discussed in more detail later in
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the text; it is mentioned here to show why early exercise often occurs in a dis
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count situation.)
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Example: XYZ is bid at $50 per share, and an XYZ January 40 call option is offered
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at a discount price of 9.80. The call is actually "worth" 10 points. The arbitrageur can
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take advantage of this situation through the following actions, all on the same day: |