Tag Archives | options expiration

Pinning stocks at expiration

There’s an excellent site that delves into research papers to find answers for questions raised by readers (CXO Advisory Group). Recently the topic was: Stock Price Pinning at Options Expiration?

A reader asked: “Do you have any research on the phenomenon of ‘pinning’ during options expiration? The theory is that there is a Max Pain price where options sellers stand to lose the least [MDW: It’s called Max Pain because it’s supposed to cause much pain for the buyers], and that they manipulate prices towards these levels.” A search of the Social Science Research Network (SSRN) separately for “pinning” and “expiration” yields the following studies, in descending order of number of downloads:

“Stock Price Clustering on Option Expiration Dates” from August 2004: “This paper presents striking evidence that option trading changes the prices of underlying stocks. In particular, we show that on expiration dates the closing prices of stocks with listed options cluster at option strike prices. On each expiration date, the returns of optionable stocks are altered by an average of at least 16.5 basis points, which translates into aggregate market capitalization shifts on the order of $9 billion. We provide evidence that hedge re-balancing by option market-makers and stock price manipulation by firm proprietary traders contribute to the clustering.”

We cannot argue with the facts, but interpretation of those facts is another matter. Max Pain theory suggests that market makers can pin stocks to the strike. The authors of this paper suggest that is exactly what happens. Their ‘evidence’? A $100 stock moves nearer to the strike price by $0.165. That’s not pinning by any definition of which I am aware. I understand that academics do research and the discovery of that small price shift is ‘evidence’ for them. However, in the real world of trading, it’s not that significant when you consider:

  • The pinning bet must be made in advance
  • The trader must pick the correct stocks because an average of 16 basis points is not very large
  • The trader must choose the right strike price
  • The strike that is closest right now may not turn out to be the correct strike price

Thus, the evidence that ‘proves’ pinning exists does exactly the opposite. It proves that it does not happen.
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Expiration Surprises to Avoid

This post was first published on Nov 16, 2010 at InvestorPlace.


Unless buying or selling options with a distant expiration date (LEAPS), each trader understands that the value of an option portfolio becomes increasingly volatile as the time to expiration decreases. I is important to be aware of specific situations that may crush (or expand) the value of your positions.

Here are six situations that should be of special concern when expiration day draws nigh.

1) Position Size

When trading options, the most effective method for controlling risk is paying attention to position size (number of options or spreads bought/sold). Smaller size translates into less profit and less reward. However, successful traders understand: minimizing losses is the key to success.

When expiration approaches, an option's value can change dramatically. The effect of time is far less on longer-term options.

Gamma measures the rate at which an option's delta changes. When gamma is high – and it increases as expiration approaches – delta can move from near zero (OTM option) to almost 100 (ITM option) quickly.

Option owners can earn a bunch of money in a hurry, and option shorts can get hammered. However, those short-lived options often become worthless. These are the conflicting dreams of option sellers and buyers.

The point is that having a position in ATM (or not far OTM) options is treacherous, and reducing the size of your position is a healthy and simple method for reducing risk.

Consider reducing position size when playing the higher risk/higher reward game of trading near expiration.

2) Margin Calls

Receiving an unexpected margin call is one of those unpleasant experiences that traders must avoid. At best, margin calls are inconvenient. Most margin calls result in a monetary loss, even if it's only from extra commissions. Think of it as punishment for not being prepared

When you hold any ITM short option position, there is the possibility of being assigned (and converting an option position to stock) an exercise notice. Early exercise is unlikely unless the option is deep ITM. However, you already know that any option that finishes ITM is subject to automatic exercise.

Exiting the trade prior to expiration makes it likely (there is still the chance of being assigned before you exit) that you can avoid the margin call.

Most put sellers (conservatively) sell puts only when cash secured. That means: cash to buy shares is already in the account. When cash is available, there is no margin call.

Those who write call options are subject to the same assignment risk. If the trader is covered, there is no problem. Upon assignment, the shares already owned are sold to honor the option seller's obligations.

When you receive a margin call, many brokers (no warning) sell enough securities (to generate cash) to meet that call. Other brokers automatically repurchase your short options (with no advance warning) before expiration arrives.

Bottom line: When you cannot meet the margin requirement, do not hold a position that is subject to early exercise. And never hold that position through expiration (when assignment is guaranteed). Find a way to exit the trade to avoid possible margin calls. For clarity: If margin is not a problem, none of this applies to you.

3) Increased Volatility

Pay attention to volatility – both volatility of the underlying stock or index as well as the implied volatility of the options themselves.

For option owners volatility is your friend. The fact that stocks are more volatile is enough to raise implied volatility, and that in turn increases the value of your options – sometimes by more than its daily time decay.

If you get lucky twice, and the volatile market moves your way, the option's price may increase many-fold. That's nirvana for option owners.

However, if you are looking at increased market volatility from the perspective of an option seller, volatility translates into fear. Whether a trader has naked short options (essentially unlimited risk) or short spreads (limited loss potential), he/she must recognize that the market (the underlying asset) can undergo a large, rapid price change.

Options that seemed safely out of the money and a 'sure thing' to expire worthless are suddenly in the money and trading at hundreds (or thousands) of dollars apiece. When an index moves 5% in one day (as it did frequently during late 2008), SPX options that were 40 points OTM in the morning were 10 points ITM by day's end. When that happens with an increase in implied volatility, losses (and gains) can be staggering.

There is good reason for the shorts to be afraid. One good risk management technique is to buy back those shorts – whenever you get a chance to do so at a low price. Remaining short, with the hope of collecting every last penny of premium, is a high risk game.

4) Reward vs. Risk

Expiration plays come with higher risk and higher reward. That's the nature of the game. In return for paying a relatively low price for an option, buyers have but a short time for the market to do its magic. Otherwise the option disappears into oblivion.

Most new traders believe they are locked into the trade once it has been made. Not true. You should consider selling those options any time that you no longer believe they can make money.

Don't sell them for a tiny premium, such as $0.05. For that price, take your chances.  But when real cash is at stake, perhaps when the option is priced near $1, then it's a difficult choice: hold vs. sell.  Make a reasoned decision.

Although it seems to be an obvious warning, when buying options near expiration day, please be aware of what must occur to earn a profit. Then consider the likelihood of that happening.

The same warning applies to option sellers. Time may be short, but when the unlikely occurs, the loss can wipe out years of profits. When there's just too little premium, cover the short position and leave the last bit of cash on the table. 

5) Option Greeks – Delta and Gamma

The greeks are used to measure risk. Once measured, it is up to the trader to decide whether risk is acceptable or must be reduced. It's important to understand the greeks of your position and how they change when the underlying moves. It's not necessary to spend hours studying the data. Use the greeks to get a look at the big picture and decide whether your position is ok as is, should be adjusted, or closed.

As has already been mentioned, delta and gamma change more rapidly near expiration (if the option is anywhere near the money). Stay alert to these changes.

6) News Events

When news is released, the underlying stock often undergoes a substantial change in price. If you have a position, or are considering opening a new position, be certain that you know whether news is pending. Such news is most often a quarterly earnings report.

If you are a risk avoider, don't hold short options with negative gamma in the face of earnings releases.

Summary: Expiration is an exciting time for traders who are either long or short options. If you want to play in that arena, understand what you are doing. If you are a more conservative trader, it's easy to exit all trades before expiration draws too near.


The November 2010 issue of Expiring Monthly will be availale Monday, Nov 22.  This month's issue focuses on commodity options.



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Expiration and iron condors

This question arrived Friday 11/5/2010 and because it was time sensitive, was answered immediately via e-mail. 


I sold [I prefer the term 'buy' – but this is not the time to quibble. MDW] a Nov IC in early Oct which included a RUT 750/770 call spread.

Delta is climbing every day, and with 2 weeks left and 16 points between current and short strike, I'm trying to decide the best route to save this with the least amount of red.

On the potential reversal side, volume is dropping on RUT, A/D line is over 200, and RSI is through the roof. So some professional feedback would be great.

Here are my current thoughts. 1) Close down shop and possibly roll up to higher strikes next week for less credit. 2) Close half the position now, and open additional contracts next week farther out. 3) Roll all 750 shorts up to 760 which is 10 points above April high. 4) Wait it out and pray. Least likely scenario. 5) Move half shorts to 760 and the other half to 780 and keep longs open. 6) Buying back a few shorts. 7) ??????????

Thanks for your feedback.



I can provide feedback on trade ideas, but I have no clue on market direction and have nothing to say about A/D or RSI.  I believe risk must be managed by what we see and how we feel about it. 

A trader who is confident that the market will decline, may feel comfortable with your position.  But lacking a crystal ball, WYSIWYG.  And risk is what we see. 

1) Closing is often, but not always the best choice.  Howeve, it is seldom a poor choice. By closing, you avoid making a poor trade in an attempt to 'keep hope alive.'  And do not ignore the emotional benefits of getting out of, and no longer having to manage, an uncomfortable high-risk position.

I agree with your attitude: looking to minimize losses.  Refusing to acknowledge that you are uncomfortable with this position is not a winning philosophy, in my opinion.

Rolling should be a separate decision.  If you find a Dec (or Jan) trade that suits, then sure – open it after taking care of the Nov trade.  RVX is rather low right now (25), and you may not like the premium available for new iron condors, but there is no reason why IV cannot move much lower. 

2) Reducing position size is very similar to exiting the entire trade. If you cannot quite get yourself to exit, then this is a good compromise.  However, there is one condition: Is holding half (or any other portion) of the position 'comfortable'?  The answer may be 'yes' when half the risk has been removed.  However, if you hate holding this, then don't.  The potential reward is obvious when expiration is near.  However, recent trading tells us that this call spread can be ATM in a single day.  Only you know how queasy that makes you.

This is not 'better' than shutting down the trade.  It is making the same trade in half the size.  In other words, I don't recommend worrying about the difference between these two choices.

If you decide to buy back the Nov call spread, then the next decision is 'how many to buy.'

3) Buying the 750/760 call spread is viable.  If you prefer to hold a position in the front-month options, then this is a good compromise choice.  It reduces risk, and that's the primary objective when making an adjustment.  The problem is that 10 points is not much protection.

How to decide on this alternative:  Cost.  Are you willing to pay the price required to gain 10 points of protection, when you may be forced to close the trade in a few days?  This is a difficult decision. However, it's one that you want to learn to make in a matter that suits your needs – because this situation is going to happen again

4) NO.  There is no praying in options trading. 


One of the problems with exiting when 'pray and hold' was considered and dismissed is deciding how much worse you will feel if this spread moves to it's maximum value. Compare that with how much worse you will feel if you exit and the market reverses.  It may seem foolish to be concerned with this comparison, but psychological factors are important to a trader.  You do not want to destroy your confidence, but neither should you be willing to take more risk than is appropriate.

It's best when you can make your choice and then ignore what might have been.  Not everyone can do that.

I am NOT telling you to exit, but do not shut your eyes.  Make a reasoned decision.  If that decision is to hold, then that is never a final decision.  You will be facing the hold/close decision several times every day – for as long as you hold this position.

5) Once again, if you cover the 750 calls and keep the 770s, you have a choice as to which options to sell.  And how many to sell.  There is nothing special about 'half' other than it's a middle of the road decision.

The specific trade mentioned leaves you short the Nov butterfly. 

6) I like this idea as a general method for reducing risk.  It provides major protection. 

There are two problems. 

  • The first is cost.  Are you willing to pay the cost?  That's why most traders who buy the 750's prefer to sell something against it to reduce cost.  (And if you choose to sell the 770s then you are closing some spreads)
  • Second: Analyze the remaining position.  It's a front-month back spread.  You own more calls than you are short and thus, cannot be hurt with a gigantic upside move.  However, a rising market can kill you when time passes and the value of your 770s disappears.  As 'good' as this trade (buying some 750s) looks, it's vital that you examine the new position and be certain you are happy to hold it.  I prefer making this trade when dealing with options with a longer lifetime.

Right now the 750s don't cost a bundle, and covering some of them makes the risk graph look much better.  But it does give you that back spread.

Future consideration:  Consider a kite spread.  Buy one (or more) 740s or 750s and sell 2 or 3 of a farther OTM call spread.  Perhaps 780/790 – although that is probably too low priced to consider when time is so short.

7) You covered the major possibilities.  Almost any position that picks up positive delta and some gamma is a good idea here.  However, if you plan to hold this position into expiration week (or to the bitter end) be absolutely clear about the fact that the 770s will most likely cease to serve any purpsoe other than to limit losses.  And those losses can be substantial. 


The big decisions remain: 

  • How much are you willing to spend to 'defend' this trade? 
  • Is it worth defending? 

It's a personal decision and I cannot tell you how to play it.  Honest I can't.  I don't know enough about you, your investment goals or how much risk you are willing to take.  I don't know if you are 65, using your retirement money or 25 using extra cash.

I recommend closing if you are seriously considering that possibility. 2nd choice, buy 750/760 spread – but not if price is above $5.  If these were Dec options, I'd recommend buying some 750 calls.

If you choose to hold, monitor closely.

Remember your goal:  You are seeking to earn money over the longer term, not only in the Nov 2010 expiration cycle.



$12 in .pdf format

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Exercising at Expiration Follow-up: A real world example

Hi Mark,

Thanks for your suggestions on my DFS trade. In fact I should have mentioned that a majority of my option positions are OTM credit spreads and iron condors.  This is the one or two speculative positions I have at a certain point. I entered the trade back in December anticipating DFS to go up, and it did. I do admit that I committed the sin of being emotional with my position and want to make even, but in this case, I also believe in the company and I do own the stock in another account with a higher cost basis. I was in a similar situation late last year, took a loss but slept well.

1) When you opened the position, and the price you paid are immaterial

2) Your position may have been born short a put spread, but now it's a naked short put

3) You 'believe in the company'?  What does that have to do with the price of tea in China?  Is owning naked long stock (or a covered call) the way you want to play this company going forward?

4) The fact that you own more stock in another account is immaterial.  Although the fact that you are already long with downside risk ought to encourage you to take less risk in this account

The cost basis of your stock is immaterial.  Only the IRS will care about that – if you ever sell the shares.

5) It is not a 'sin' to get emotionally involved with your decisions.  That's a trait that is difficult to overcome, but it is necessary if you want to be a successful trader or investor

It is not a 'sin' to try to get back to even.  However, it is an exercise in bad judgment. You obviously plan to continue to trade.  It should not matter which stock, or which specific position, provides profits.  Your goal is to earn maximum profits with minimal risk.  You are not doing that with this position.

6) One way to break that 'get back to even' mentality is to ignore your entry price for a trade.  Write it in your journal, but do not pay any attention to that price.  Pay attention to current risk and reward.

I recognize that my stance on 'forget about break-even' is the minority view, but I stand by my belief that it's the only view that makes sense.  Consider this:  You hang onto a trade to get one more dime out of it.  You need that one more dime to break even.  While waiting for the dime, the stock moves and you lose two bucks.  Nice risk/reward.  Maximum gain is a dime, maximum loss is ???

On the questions you raised, this is what I think:

Writing covered calls the best play? By the middle of expiration week, I have a couple plans in place:

Plan A: Close the spread with nice profit.   That did not happen 

This an example of you making a trade decision based on profit or loss and not on risk/reward.  It's your money, but this is not a good idea – in my opinion.

Plan B: Short DFS stock so I am completely out of the position by Monday.   I was going to do it on Friday if Plan A didn’t work, but DFS dropped further, so I decided that was not the best time to lock in an exit price 

Again, a decision based on the fact that it would lock in a loss to exit.  This is not a good decision based on risk/reward.  You are free to trade that way, but my recommendation is to learn to think differently.

Plan C: Exercise the $15 call and let the $17.5 call expire; then exit in the near future.  I chose to write covered calls.

A viable plan.  A reasonable strategy.  However, if you chose this backup to a backup plan just to avoid taking a loss, it's no longer a viable plan. 

There is one thing that I did not think about, and that is to roll the position to a later month.  I usually view different expiration dates independently, and I did not have the work done the night before. I guess I should start looking into this possibility. 

Sure, be aware of the possibility. Plan ahead.  If you can get a price you would be happy to get to roll, then this is a good plan.  But rolling just to do something – which is what you did this time, albeit with a weekend long leg – is a bad idea. 

Rolling is not some magical trade that turns losers into winners.  It's a decision to exit one trade and enter another.

Less risky plays? This position as I explained earlier, is one of the speculative positions I have, so by design if I lose 100%, I will be fine with it (on this one, I see that with a little more time I can turn that to a profitable position). I used to speculate with vanilla long calls but I do not feel comfortable with that any more.

When this trade was made, losing 100% meant a loss of $88.  Now it represents a potential loss of more than $1,400.  Are you still willing to lose 100%?  Is this a good speculation?  Are there no other bullish plays that satisfy you?  Must you own stock?

Let me see if I have this right:  You do not feel comfortable with the risk of owning calls, but you are ok with the risk of owning stock? That's not how I measure risk.  But the nice thing about options is that there are so many alternatives that we can each take the risk we are willing to hold.

Naked long over the weekend a good idea? Acceptable, I’m comfortable with it.

Covered calls ONLY because I refuse to take loss? Part of the reason why I exercised, but I also believe in the stock itself.

Gibberish.  If you believe the stock is moving higher  – can't you find a less risky way to be long?

Once again, thanks very much.

Thanks for the question and follow-up.



"I thoroughly enjoyed your book “The Rookies
Guide to Options
”.  The book has paid for itself many times
over.  Thank you." VR


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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.


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

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

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
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

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.


Expiring Monthly: The Option Traders Journal


Vol 1 No 2 published today


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

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


Options expiration.  When you sell options, it's an anticipated event.  When you own options, it's something to dread.

At least that's how most people view it.  There's much more to an options expiration, and if you are a newcomer to the options world, there are things you must know and steps you should take to avoid unpleasant surprises.  However, if you enjoy nightmares, feel free to disregard this entire post.

Many investors come to the options world with little investing background.  they consider the 'options game' to be simple:  You buy a mini-lottery ticket.  Then you win or you don't.  I have to admit – that's pretty simple.  It's also a quick path to losing your entire investment account.

It's important to have a fundamental understanding of how options work before venturing onto the field of play.  But not everyone cares.  It you are someone who prefers to keep his/her money, and perhaps earn more, then those option basics are a must for you.

No one takes a car onto the highway the
very first time they get behind the wheel, but there is something about
options, and investing in general, that makes people believe it's a
simple game.  They become eager to play despite lack of training.

Today's post provides some pointers for handling an options expiration.  Options have a limited lifetime and the expiration date is always known when options are bought and sold.  For our purposes assume that options expire shortly after the close of trading on the 3rd Friday of every month. (Expiration is the following morning, but that's just a technicality as far as we are concerned)


Please don't get caught in any of these expiration traps.

1) Avoid a margin call 

New traders, especially those with small accounts, like the idea of buying options.  The problem is that they often don't understand the rules of the game, and 'forget' to sell those options prior to expiration. If a trader owns 5 Apr 40 calls, makes no effort to sell them, and decides to allow the options to expire worthless, that's fine.  No problem.  However, if the investor is not paying attention and the stock closes at $40.02 on expiration Friday, that trader is going to own 500 shares of stock.  The options are automatically exercised (unless you specifically tell your broker not to exercise) whenever the option is in the money by one penny or more, when the market closes on that Friday.

In my opinion, this automatic exercise 'rule' is just another method that brokers use to trap their customers into paying unnecessary commissions and fees.

On Monday morning, along with those shares comes the margin call.  Those small account holders did not know they were going to be buying stock, don't have enough cash to pay for the stock – even with 50% margin – and are forced to sell the stock.  Rack up more costs for the investor and more profits for the broker.  Please don't forget to sell (at least enter an order to sell) any options you own. 

2) Don't exercise

If you own any options, don't even consider
exercising.  You may not have the margin call problem described above, but did you buy options to make a profit if the stock moved higher?  Or did you buy call options so that you could own stock at a later date?  Unless you are adopting a stock and option strategy (such as writing covered calls), when you buy options, it's generally most efficient to avoid stock ownership.  Here's why.

If you really want to own stock, when buying options you must plan in advance, or you will be throwing money into the trash.  For most individual investors – at least inexperienced investors – buying options is not the best way to attain ownership of the shares.

If the stock prices moves higher by enough to offset the premium you paid to own the option, you have a profit.  But, regardless of whether your investment has paid off, it seldom pays for anyone to buy options with the intention of owning shares at a later date.  Sure there are exceptions, but in general: Don't exercise options.  Sell those options when you no longer want to own them.

Example: Here's the fallacy.  The stock is 38, you buy 10 calls struck at 40, paying $0.50 apiece.  Sure enough you are right.  The stock rallies to 42 by the time expiration arrives.  You know a bargain when you see one, and exercise the calls, in effect paying $40.50 per share when the stock is worth $42.  This appears to be a good trade.  You earned $150 per option, or $1,500.

Before you congratulate yourself on making such a good trade, consider this: The truth is that you should have bought stock, paying $38.  If you are of the mindset that owning shares is what you want to do, then buying options is not for you.  And that's even more true when buying OTM options.

If you are an option trader, then trade options.  When expiration arrives (or sooner) sell those calls and take your profit (or loss).  There's nothing to be gained by exercising call options to buy stock.  Why pay cash for an option, then hope the stock rises so that you can pay a higher price for stock?  Just buy stock now.  If you lack the cash, but will have it later, that's the single exception to this rule.

If this exception applies to you and you are investor, not a trader, then buying the Apr 40 calls is still the wrong approach.   Buy in the money calls – perhaps the Apr 35s.  You might pay $3.60 for those calls.  If you do eventually take possession of the shares, the cost becomes $38.60 (the $35 strike price plus the $3.60 premium) and not $40.50.  Buying OTM options is not for the investor.

to be continued…


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Trading Options Near Expiration

This post was recently published at Options Zone, with the clever title: How
to Avoid the Wrath of Gamma at Expiration

When it comes to trading near expiration, there are almost as many opinions about what to do as there are traders.  I'm a strong believer that it's best to avoid holding any positions into expiration, but that's especially true for short positions.

The rapid time decay and the thrill that comes with watching options (that you sold) expire worthless, makes it very tempting to hold onto short positions.  Part of the time it just feels like a waste of money to pay $15 to $25 for an option that is 'obviously' going to be worthless next week.

More than that, when an option is out of the money by a small amount – perhaps 2%, it's tempting to look at that wonderful ticking clock and count how much you are making every hour.  Ah yes, beautiful theta is a joy forever.

Alas, options with positive theta come with negative gamma.  For the option short, you can describe theta and gamma:  "It was the best of Greeks; it was the worst of Greeks."

Nothing results in larger accelerating losses than owning positions with negative gamma.  Watching the stock race from being out of the money to moving into the money can be a paralyzing experience.  We all 'know' that this cannot happen to us and that each of us would simply buy back the options before it became a problem.  If you've never been there, if you've never watched an option move from $0.25 to $1.00 in a heartbeat, then you just don't get the situation.  

If you didn't want to pay a quarter, how in the world are you going to convince yourself to pay a buck?  And while you are trying to pull the trigger, the option is now priced at $1.25 and then $2.  Stubborn now, there's no chance you will decide to pay that 'outrageous' price.  Convincing yourself that someone is manipulating the stock price as expiration approaches, you do nothing.

Sometimes this stubbornness is rewarded, and the stock stops its movement and retreats.  Perhaps a rumor drove it higher and the denial is lowering the stock price.  The problem with being rewarded in this situation is that no lesson is learned and next time you may not be so lucky.

At other times, this is just the beginning.  The next morning the stock opens higher and keeps on moving.  At some point the pain is too great and you cover.  Is that $4 per option, $6? Who knows.  But it doesn't matter.

What does matter is that you were so in love with positive theta that you ignored its partner, negative gamma.  That particular Greek does not like to be ignored, and every so often gamma rears its head and takes no prisoners.

In my opinion, the risk of holding short options into expiration far outweighs any potential rewards.

The Other Side

Of course, there's another side to the story.  Jeffrey Augen wrote an entire book based on the idea of teaching his readers how to Trade Options at Expiration.

Augen book

Trading Options at Expiration: Strategies and Models for Winning the Endgame

For the right trader, these methods are worthwhile.

One thing is certain, whether you buy or sell options, trading near expiration can be exciting or frightening – or both.



Lessons of a Lifetime

Now available in KINDLE format


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Random Assignment of Exercise Notices

Hi Mark,

Some time ago you talked about option sellers getting assigned exercise notices by a
random selection, when an option owner exercised. Let's  say a seller shorted
100 contracts.  Is it right to presume that there is a possibility that the
seller receives a partial assignment, when there is insufficient
exercising buyers to cover the entire 100 contracts?



partial assignments are common. Much less common at expiration.  In your example, there must be a partial assignment.  If fewer than 100 options are exercised, then it's impossible to be assigned on all 100.

For clarity, here's the proper usage for the terms exercise and assignment.

  • An option owner exercises
  • An option seller is assigned

Note: This common mistake:  An option seller is NOT exercised.  He/she is assigned.

The first thing to know is that brokers
are allowed a bit of flexibility in choosing how exercise notices are
handed out (assigned) to clients.  However, they get to select only one
method.  Once chosen the broker is not allowed to change methods.  There
are two basic choices:  random selection (most common) and first
in/first out.

I wrote to the Options Clearing Corporation (OCC) to verify that the system still resembles the way it worked when I was still on the trading floor. (I find it difficult to believe that was ten years ago)  I appreciate their willingness to supply a very useful answer:

"The OCC would put all of the short positions on the wheel — firm by
firm. If firm A has 100 short positions but it lands on position 99,
then that firm gets assigned 2 contracts [#99 and 100] and the next assignment goes to Firm

Typically there are two other random features: the "assignment
quantity" which is typically 25 contracts, and the "skip interval". If
the exerciser exercised 30 contracts, the first 25 would be assigned to
the first 25 open positions and the skip interval would be implemented
— the next 5 contracts would go to the firm(s) with the next 5 short
positions after that interval."

If you are not familiar with the process or some of the terminology, this is how the process works:

Some people exercise a specific option on a given day.

1) The OCC electronically 'spins a wheel.'  On that wheel is every clearing member (your broker, for example) that has at least one customer with a short position in the specific option being assigned notices. NOTE: Long positions held by other clients are ignored. There is no off-set.

2) For each short option, the broker is assigned a space on the wheel.

3) The wheel is spun and stops at a specific firm (firm A in the OCC's example above).  It also stops at a specific option number.  In the example, the firm has an unspecified number of clients who are short a total of 100 options.  If the wheel stops on #99, then the first 98 'escape' being assigned – for the moment.  If all outstanding short options are assigned, the process will go all around the wheel and select those 98 options at the end of the process. 

3) This is one of the reasons why someone may receive a partial assignment

4) The OCC uses an interval.  That means they assign (often 25) notices to 25 consecutive places on the wheel.  Then the 'skip interval' is used to pass over a group of places on the wheel.  After that interval, the process starts again.  It's possible that the assignments go to the same broker, and that broker may still hand them out to the same account.  But it's also possible that the skip interval moves the wheel location to another clearing member.

5) The process is repeated.  Assignments are handed out, the wheel moves, some shorts are bypassed.  When all exercises have been assigned to a clearing member, the process ends.

6) Back to the broker.  There are choices for handing out random assignments.  Each specific option can be randomly assigned.  Or the broker can spin it's own wheel, pick an account and assign as many as possible to that account before selecting another.  It may or may not have a skip interval.

If you ask your broker, my guess is that you will have difficulty finding someone who knows the answer.  It shouldn't really matter to you, as long as the process is truly random.

7) Expiration.  The process is the same at expiration, but usually 100% of all ITM options are exercised.  When an option is slightly ITM (a penny or two), some
options expire worthless (because the owner declined to exercise). The
lucky (or not, depending on your point of view) people who 'slide' (go
unassigned) are the ones who are left over at the end of this assignment

8) So if you are short that 100-lot, you will receive a partial
assignment in these situations:

a) Fewer than 100 contracts are assigned that day

b) The skip interval results in some of your shorts being ignored

c) Your broker's process results in a partial assignment

d) Your broker is firm A in the example, and only a portion of your position is assigned an exercise notice


Expiring Monthly: The Option Traders Journal

List of Prize Winners in Random Draw

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