exercising put option

[Llxa]

I'm not sure if someone mentioned this above, but I can't think of any good reason to exercise a put option. Sometimes people exercise a call option in order to capture a dividend, but when you exercise a put option, you're throwing away all time premium (extrinsic value) left in the put option. Since american options can be exercised at any time, the premium of the put option will contain both intrinsic (if the option is ITM) and extrinsic (time premium). The intrinsic value will always be equal to the amount that the option is ITM because someone holding the option can exercise it at any time and always get that amount. Only case that I can think of to exercise is if the option is way deep in the money or not liquid so that the bid / ask spread is wide, but even then if the option is priced just one cent or two less than the intrinsic value, someone will buy as they could use it as part of a risk free trade. Also, most brokers aside from IB charge an extra fee for exercise / assignment.

Apparently the ONLY incentive to exercise a put option early is if the interest rate is extremely high and selling the stock via exercising the put option at the strike price and then investing the proceeds in interest-bearing investment would earn large enough return than all the loss in intrinsic and extrinsic values on the options and all the potential capital gains from holding the stock. http://tradingmarkets.com/recent/learn_when_you_should_exercise_an_option_early-640882.html

But since the interest rate is so low in North America there should be no incentive to exercise your put option aside from REALLY wanting to get rid of your stock but nevertheless I have had put options exercised against me on quite a few occasions when they went into money. The Options Clearing facility of both Canada and US have this policy that any options ITM for just $0.01 is AUTOMATICALLY exercised UNLESS the trader gave explicit instruction to the broker to never exercise any options. That's good that just allows me to make a killing when I am able to sell them at much higher profit later on as I did on all of the occasions.

 

[ET180]

I've never actually had any of my short puts exercise early.

 

[stockoptionstrader]

No Put options is for selling your shares. If you want to exercise your puts that you bought, you would've already bought the underlying stock BEFORE you have bought the puts and still have them in your portfolio. Using your example, assuming you still have the underlyings in your portfolio, you would sell your shares at $30 strike price so if the underlying is currently at $20, you would've made a profit of $10 (30 - 20) per share minus all the exercise fees and commissions and etc. But if you have bought the underlying shares at $30, then you wouldn't have made any profit because the strike price is also at $30. $30 - $30 = 0. So as you can see, put options are like insurance on the shares that you bought in that it allows you to sell your existing shares at the strike price when the market price of the underlying shares is lower so that way you are protected from any losses that you may incur on your stock. Now just like any insurance, if everything is going well, then the policy is worthless. Same thing with the put option. Let's say the current market price of the stock is now $40, higher than the put option then the put option is worthless because you wouldn't want to exercise it. WHY would you want to exercise the put option to be able to sell your stocks at $30 when you can sell them for $40, $10 higher in the market?

Hope this helps.

You said I would have bought the shares before my put option. Right now I have the put option at 30$ strike price. When the stock is at 20$, Can I still buy 100 shares at 20$ after I purchased the put and exercise it without being short? TIA

 

[CBC]

I don't understand you guys, why your saying 100 short.....

If you have a put option then you have reserved the right to sell the shares at the strike price. So when you exercise you buy the shares at $20 then sell (execute) at $30...

 

[SteveH]

CBC,

I've never seen this explained in a book as it's probably hardly ever done but what about this situation:

You buy 1 put contract of X stock at $40. The stock plummets to $5 in days. Instead of selling the put contract, you decide to exercise it. I thought what would happen is that 100 shares of the stock would be borrowed for your account at a price of $40 per share, giving you an open short position which you still would have to be closed by buying the 100 shares back at some later date (under your control).

 

[CBC]

I've never exercised b4, which is what a lot of people on this thread have kinda been saying because you get the premium if you close out.

I understand you wanting to know what happens.

Yes you can buy the shares just before exercising. You don't even have to buy them at all, which is how a lot of people trade options .

I was also under the opinion that you don't actually have to buy the shares to exercise. I thought ( how it works with FOPs ) is that the exchange goes to the spot market and supplies the underlying to the seller of the put.

How long have you been trading?

 

[donnap]

I've never exercised b4, which is what a lot of people on this thread have kinda been saying because you get the premium if you close out.

I understand you wanting to know what happens.

Standard American style options are contracts for delivery, regardless of other positions of the holder or seller. The exercise and assignment is a transaction between these two parties.

If the holder and seller of an Amer. equity put do not hold any position in the UL, and the holder exercises - then the holder is -100s and the seller is +100s.

It is the same for FOPs (for delivery), where the holder would be -future and the seller +future.

It is up to the parties how they handle the delivery, which they may have already done.