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?'
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.