Tag Archives | assignment notice

Options Expiration. Six Things to Know, Before you Play the Game. Part II

Over at the Options Zone, this post
(slightly edited) was published
on April 14, 2010.

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Part I

3) Do not fear an assignment notice

If you are assigned an exercise
notice on an option you sold, that is nothing to fear, assuming you are
prepared.  By that I mean, as long as the assignment does not result in a
margin cal.

Many novices are truly fear receiving
an assignment notice.  It's as if they believe 'something bad has
happened.  I don't know what it is, nor do I know why it's bad.'

Being assigned prior to expiration is
usually beneficial from a risk-reduction perspective.  More on this
topic at another time.  


4) European options are different

Most options are American style
options and all the rules you already know apply to them.  However, some
options are European style (no, they do not trade only in Europe), and
it's very important to know the differences, if you trade these options.

Most index options are European
style:  SPX,
NDX, RUT (not OEX).  These are index options and not ETF (exchange
traded fund options).  Thus, SPY, QQQQ, IWM are all American style
options.

a) These options
cease trading when the Market closes Thursday, one day prior to
'regular' options expiration day.

b) The final 'settlement' price – the
price that determines which
options are in the money, and by how much – is calculated early in the
trading day on Friday, but it's not made available until approximately
halfway through the trading day. 

The settlement price is NOT a real
world price.  Thus, when you observe an index price early Friday
morning, do not believe that the settlement price will be anywhere near
that price.  It may be near, and it may be very different.  
It is calculated as if each stock in the index were trading at its
opening price – all at the same time.  Be careful.  Often this price is
significantly higher or lower than traders suspect it will be – and that
results in cries of anguish from anyone still holding positions.  It's
safest to exit positions in Europeans options no later than Thursday
afternoon.

c) European options
settle in cash.  That
means no shares exchange hands.  If you are short an option whose
settlement price is in the money, the cash value of that option is
removed from your account.  If you own such options, the cash value is
transferred to your account.


5) Don't hold a position to the bitter end

It's not easy to let go.  You paid a
decent premium for those options and now they are down to half that
price.
That's not the point.  You
bought those options for a reason.  The only question to answer is
this:  Does that reason still apply?  Do you still anticipate the stock
move you had hoped would happen?  Has the news been announced?

If there is no good reason to hold,
cut your losses and sell out those options before that fade to zero.

Is the shoe on the other foot?  Did
you sell that option, or spread, at a good price and then see the
premium erode and your account balance rise?  Is that short position
priced near zero?  What are you waiting for?  Is there enough remaining
reward to hold onto the position, and with it, the risk?  Let some other
hero have those last couple of nickels.  Don't take big risk unless
there's a big reward.  Holding out for expiration – especially when it's
weeks away is not a good plan.


6) Negative gamma is not your
friend

When you are short options, you are
short gamma.  Most of the time that's not a problem.  You get paid a
nice rate of time decay to hold onto a short position – reducing risk
when necessary.  But show some respect.  Negative gamma is the big, bad
enemy. When the reward is small, respect this guy and get outta town. 
Cover those negative gamma shorts, take you good-sized profit and don't
bother with the crumbs.


Options expire monthly.  It's important to understand the risks and rewards associated with trading options as expiration day approaches.

667


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