Options expiration brain-fart

October 3, 2014 2:33 PM

Ok financial mavens, and in particular, option trading experts, what happens in this scenario?

I inadvertently let a put option expire in the money this afternoon. What's going to happen Monday morning as my brokerage will automatically exercise the option (and FWIW there's enough money to cover any transaction). Let me simplify the numbers for clarity:

1 Put option @100
Today's close @ 95 (let's assume it'll open monday at same price)

On Monday, will my broker buy 100 shares long costing me 95 x 100 = $9500 that i can immediately sell for 100 x 100 = $10,000 ??

or

Will my brokerage short 100 shares @ 100 = $10,000 that I can immediately buy back at 95 x 100 = $9500 And what if there are limited or no shares available to short?


Any other possibility? Having a hard time getting my head around this one.

posted by teg4rvn to Work & Money (9 answers total)

It's an option, not a short sale, not a margin purchase. That means you had the option (but no obligation) to sell stock at 100 if you had wanted you. But you let it expire, which means you chose not to exercise. Nothing will happen. You simply lose the premium you paid back when you purchased that option.
posted by mono blanco at 3:56 PM on October 3, 2014

Oops, I may be wrong. Some brokers will exercise in-the-money options you your behalf upon expiry. In that case they'd by the shares long @ 95 then sell them to the seller of the put @ 100. Or they may simply net it out and deposit the 5/share proceeds in your a/c.
posted by mono blanco at 4:02 PM on October 3, 2014

Response by poster: @mono blanco actually that's the only possibility that I know is NOT true. in-the-money options, as i stated in my question, are automatically exercised at expiration. I'm just looking to find out exactly what will happen.
posted by teg4rvn at 4:03 PM on October 3, 2014 [1 favorite]

Response by poster: thx for correction :)
posted by teg4rvn at 4:04 PM on October 3, 2014

Best answer: As of right now (not Monday morning), you are short 100 shares @ $100. The above answer is incorrect. In-the-money options are automatically exercised unless you give your broker specific instructions not to. The exercise cutoff time is usually 5:30PM on Fridays although your brokerage may have earlier cutoff times.

The primary concern, from a retail trader's standpoint, is that you have enough margin in your account to cover the short position; otherwise your broker might liquidate it on Monday.
posted by pravit at 4:07 PM on October 3, 2014

And what if there are limited or no shares available to short?
Then you have to pay your broker the borrow cost associated with being short the position, and the broker might buy in your short position if they can't locate any stock.

(also technically, the mechanics of the expiration and exercise happen over the weekend, but from a risk standpoint you were short the stock as soon as 5:30PM passed).
posted by pravit at 4:43 PM on October 3, 2014

Former professional options trader here. Pravit is right, your put option will be automatically exercised and you will be short 100 shares of the stock as of Friday afternoon, assuming there is enough borrow available and your account has adequate margin. You can buy back the shares on Monday and close the position, or stay short the 100 shares of stock if you so choose.
posted by Guernsey Halleck at 11:45 AM on October 4, 2014

Also, for posterity in case I wasn't clear above:

1) When options are exercised, you lose the optionality and have outright stock risk. Meaning if you were long 1 contract of the 100 strike put and the stock closes at 95 on Friday expiry, you become short 100 shares @ $100. If the stock gets taken out for $200 over the weekend, you lose $10,500. There is no scenario in which you magically get the $5 without having to do anything. The broker does NOT deposit the cash value of option intrinsic in your account. You have risk. The only exception would be if it was a cash-settled option (e.g. SPX index options).

2) For this reason, retail traders should close out option positions prior to expiry unless they specifically want the outright stock position and have the margin to carry it.

3) There are only a few cases in which you would tell your broker not to auto-exercise an option position, or intentionally exercise an out-of-the-money option. If you are long the 100 strike put and it expires at 99.99, you would rather give up the 1c of option intrinsic than carry the risk of being short 100 shares @ $100 over the weekend. Conversely, if you were long 1 contract of the 100 strike put and long 100 shares as a delta hedge, and the stock expired @ $100.01, you would rather exercise the put and sell stock at a 1c loss than carry the long stock position. If you are SHORT the option and it expires near strike, then you get to play assignment roulette and will come in to a stock position of unknown size on Monday (another reason to close the position before expiry).
posted by pravit at 1:46 PM on October 4, 2014

Response by poster: OP follow-up: What pravit said is exactly what happened. Over the weekend I checked my online statement at my brokerage and I was the owner of -100 shares. I also had a note from their customer service that I was expected to close the position right away on my own or they essentially would do it for me. I assume this was because of the difficulty borrowing shares to short.
posted by teg4rvn at 1:50 PM on October 8, 2014