Tag Archives | under parity

There is no substitute for an education

I recently received an email message from a true options beginner.  He made a trade, did not understand the trade and wrote to ask about it.

This is simply the wrong sequence of events.  It's mandatory to ask the questions first, and if and only if, you understand the answer, then it's okay to make the trade.

This gentleman owns 300 shares of a given stock and wrote three call options at an unbelievably high premium.  The stock is trading near 6 and he wrote three Jan 7.5 2011 calls.  These are nicely out of the money, but he collected a premium of $6.40.

As I am sure most readers are aware, these must be non-standard options.  My correspondent also knew these were non-standard options, but did not know what that means.

Non-standard call options require delivery of something other than 100 shares of stock when the writer is assigned an exercise notice.  Due to a special dividend, the deliverable is 100 shares of stock plus $217 cash.

[ADDENDUM: The truth is that there is another non-standard option with the same strike and expiration.  He may have sold that one – and it requires delivery of $425 plus 20 shares of a different stock, in addition to 100 shares of the underlying.  It can be treacherous out there.]

The sad news is that he sold these calls under parity – for less than their intrinsic value.  There's nothing to be done except to learn a lesson.  He thought he had made a great trade, but decided to ask my advice.  Sadly the advice came too late.

This situation truly saddens me. 

Please learn first, trade later.


EM_Button Contrib Ed

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