Quote from mynd66:
So will the broker just instantly cover the short position at market price? If XYZ is trading below 105 won't I see that? Why do I exercise the 105 call and lose more on the spread rather than let it expire worthless? Maybe that is where I am not understanding when you say gamble. I don't get the sequence of events that take place on Monday following expiration.
You are making this more complicated than it is.
1) You have $500 in your account. You cannot be short 100 shares of a $100 stock.
2) Your broker will do one of two things - and it depends on who your broker is. You will have to call EARLY Monday and ask what they are going to do.
Choice 1: They will enter a market order and buy the stock at whatever price they have to pay. They will not care about getting you a decent price.
Choice 2: They will issue a margin call, requiring you to deposit sufficient cash immediately. They may give you a day or two, but an account as small as $500 is probably not qualified to be a margin account.
Expect that they will choose choice 1.
If you can get permission to trade pre-market on Monday morning, you may be allowed to try to buy the stock yourself. But if the position is not covered by the time the opening bell rings, my guess is that the broker will just buy 100 shares for you.
3) If the stock is trading below 105, yes you will see that. You ask: Why do you exercise the call? You don't. You cannot. As has already been explained to you, the option no longer exists on Monday. Your last chance to exercise was Friday, shortly after the market closed for trading.
4) On Monday, you want to know the sequence of events?
You look at your account and see what your position is.
That's all that happens.
If you failed to exercise your long call, you are short 100 shares. It's too late to do anything, and the shares must be covered immediately (in your circumstances. Other investors, with larger accounts, have the right to remain short those shares)
5) When I say gamble, I mean this: You could have intelligently exercised your call last Friday. That would have given you no residual position. You would have lost $200 and that's that.
You are now short 100 shares. That's a big gamble because if the stock opens above 105, then you are going to lose more than $200. It may even be as much as $1,000 if you are unlucky.
But, if the stock opens lower than 105, you will lose less than $200. If you get lucky and the stock opens at 101, you wind up earning $200.
That's the definition of gambling. You closed your eyes, spun the wheel, and where it stops...
Mark
