Are OTM Options Exercisable?

First off, I love your book! And THANK YOU for doing this blog–you definitely spend a lot of time on this free service for your readers… it is extremely appreciated!

Please forgive the basic nature of my question; my options trading career is in its infancy stage.

When an option is OTM at expiration, does it always expire worthless?

…Say the underlying goes a little toward one of the short options of an iron condor.  The loss builds, but does it build past the point of no return? Does it incur such a big loss that even if the option is OTM at expiration, there is still a loss?

Or is it always the case that 'if an option is OTM at expiration, then that option expires worthless?'

 
Rachel

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Thanks Rachel,

It's a basic question, but important.  If you don't know the answer, it's difficult to proceed with learning more about options.  That's why it is important.  Thanks for asking.

There are two replies.

The first is the 'universal answer.'

1) When an option is OTM at expiration, yes, it always expires worthless.

However, 'always' is more like 99.99%, than 100%

2) The owner of an option has the right to exercise.  That right is not revoked just because the option is OTM.

Thus, when an option is OTM by one or two pennies, it is possible – unlikely – but possible that the option owner would want to exercise.  The details are not important, but one possibility:

a) A trader is short stock and bid $49.98 to cover the short.  He/she was unable to get stock at his price.  Yet, if the stock closes at $49.99, he may decide to exercise his expiring calls with a 50 strike price – to cover his short stock and not hold the risky position over the weekend.  He ends up paying $50 instead of $49.98, but his risk is eliminated.

b) Even if the option is OTM by a dollar or two, it could be exercised.  This is also very rare. news is issued Friday, right after the market closes.  It is 'obvious' that the news is good or bad and that Monday's stock price will not be the same as Friday's closing price.  Thus, OTM options (calls for good news and puts for bad news) may be exercised – if it were thought the option would be ITM on Monday morning.  This is rare, but it does happen.

Regards

841

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5 Responses to Are OTM Options Exercisable?

  1. joe 11/27/2010 at 1:42 PM #

    Mark,
    I have a question that is probably very basic.
    If you short sell stock and also write OTM put options against it, does it mean you keep the credit received from the short puts and also profit from having the stock assigned to you which means your short position is closed.

  2. Alec 11/27/2010 at 3:50 PM #

    Welcome back, Mark. 🙂

  3. Mark Wolfinger 11/28/2010 at 10:26 AM #

    Joe,
    The strategy you describe is called ‘covered put writing.’
    Yes, if you are assigned an exercsie notice on that put you sold, your position is closed. The stock you were short was ‘bought in’ when you buy stock via the put assignment.
    You keep the premium from the option sale plus and profits from being short the stock.
    Basic questions are good. You don’t want to misunderstand the basics.
    Regards

  4. Mark Wolfinger 11/28/2010 at 10:27 AM #

    Alec,
    Thanks. I wasn’t gone very long.

  5. Joe 11/28/2010 at 1:57 PM #

    Thanks Mark,
    Its great to be able to ask a question and get an quick genuine accuarate response.
    Thanks heaps