Covered Call ITM/ Assignment Question

V

vopiscus

A question about assignment:

Let's say I buy-write on 100 shares of GE stock @ 27.03, May 15 expiration, 27.50 Strike Price, and receive a $.15 covered call premium ($15).

Now let's say that on the close on Friday, GE is at 27.51

Everything I've read says that the OCC/broker-dealer policy is to automatically assign any position that is ITM by over $.01, unless otherwise instructed.

But let's think about the perspective of the person that who OWNS the calls I sold. They paid me $.15 per share for the right to buy 100 shares at 27.50. On Saturday, they are automatically sold the 100 shares for $27.50.

I don't understand why they would want this to occur, because it will cost them 27.50 for each share, PLUS it has already cost them $.15 to buy the rights. So their overall cost is $27.65, which does not compare favorably to the closing price of $27.51

What am I not getting here? Am I not understanding the terminology?

Please help. Thanks.
 
The scenario you are describing would be extremely rare and if it did happen perhaps the buyer doesn't care about the nickles. He can take the shares or not take the shares - six of one, half dozen of the other.



:)
 
Perhaps. But not if we were talking about 100,000 shares, etc, instead.

I still don't understand why the ITM by .01 rule exists.

OTM-Options --- If you were selling covered calls of any security, strike price 200, and the security closed at 200.01 on expiration day, would you expect to have your shares assigned or not? Would you say it's 50-50? Based on what I read it's more like 99.99 - .01. I am trying to figure out why.
 
vopiscus said:
Perhaps. But not if we were talking about 100,000 shares, etc, instead.

I still don't understand why the ITM by .01 rule exists.

OTM-Options --- If you were selling covered calls of any security, strike price 200, and the security closed at 200.01 on expiration day, would you expect to have your shares assigned or not? Would you say it's 50-50? Based on what I read it's more like 99.99 - .01. I am trying to figure out why.
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The number of shares is a moot point.




:)
 
vopiscus said:
A question about assignment:

Let's say I buy-write on 100 shares of GE stock @ 27.03, May 15 expiration, 27.50 Strike Price, and receive a $.15 covered call premium ($15).

Now let's say that on the close on Friday, GE is at 27.51

Everything I've read says that the OCC/broker-dealer policy is to automatically assign any position that is ITM by over $.01, unless otherwise instructed.

But let's think about the perspective of the person that who OWNS the calls I sold. They paid me $.15 per share for the right to buy 100 shares at 27.50. On Saturday, they are automatically sold the 100 shares for $27.50.

I don't understand why they would want this to occur, because it will cost them 27.50 for each share, PLUS it has already cost them $.15 to buy the rights. So their overall cost is $27.65, which does not compare favorably to the closing price of $27.51

What am I not getting here? Am I not understanding the terminology?

Please help. Thanks.
More...

vopiscus,

The price you sold or bought the options is not relevant to the situation. And, the person you did the trade with is not your counterparty anymore. All that matters is what the closing stock price is at expiration, what happens after the close but before the time when the buyer needs to make a decision, and what the buyer of the options wants their position to look like Monday. Options are exercised that are a little OTM all the time for risk. Options are not exercised all the time that are a little ITM. I once had a client that was short puts in VXX, where the close was $0.75 OTM and he was assigned 16,000 shares.
 
vopiscus said:
Perhaps. But not if we were talking about 100,000 shares, etc, instead.

I still don't understand why the ITM by .01 rule exists.

OTM-Options --- If you were selling covered calls of any security, strike price 200, and the security closed at 200.01 on expiration day, would you expect to have your shares assigned or not? Would you say it's 50-50? Based on what I read it's more like 99.99 - .01. I am trying to figure out why.
More...

The 0.01 ITM rule exists to streamline expiration. Without it, all option buyers would have to contact their broker and those brokers would need to contact the OCC. Too much work for nothing.
 
rmorse said:
The 0.01 ITM rule exists to streamline expiration. Without it, all option buyers would have to contact their broker and those brokers would need to contact the OCC. Too much work for nothing.
More...


Got it. So while you brought up a few examples of ITM's NOT being exercised and OTMs being exercised, would you still say that a "rule of thumb" is that if it's over by .01, it will be exercised? (I know that making a decision based on a "rule of thumb" is not wise, but just wondering in general.)
 
The majority of expiring options follow that. The more illiquid and volatile the stock is, the less relevant the close is. Take GE vs PCLN. GE is around 27 and PLCN is around 1183. If GE closed at 27.01, the risk of not covering a hedge or cover is low over the weekend. For a position in PLCN, would you care about a few cents? If you had a spread on or stock vs your options, you would do what is right for your position. You would try to close or roll toward the end of the day but sometimes you can get it off or the stock moves a lot near the close.

Does that help?
 
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