Option question

S

stockoptionstrader

I have a question about exercising options.

I have heard you can always exercise a stock option when it's american style, even if there is no volume. (because when you exercise you don't need to sell, so volume doesn't matter).

But I have seen options like this:

Stock price is now around 17.60$.

You can buy the 17 february 19$ strike price option for a premium ask price of 0.80 or 80$. So let's say you buy 3 contracts so you pay 160$.

If you buy the option and you exercise the option immediately, you make profit, is this possible?

17,60 x 3 contracts = 17,60 x 100 = 5280 $ you pay for the shares.

When you sell them directly you get: 19/17.60 = 1.079, you have immediately 8% profit.

8% profit on 5280 $ = 456 $.

456$ - 160 $ (the premium you paid) = 296 $ profit.

Is this calculation right?

TIA
 
Unfortunately, this calculation is incorrect.
1. 3x80 = 240 not 160, let's just assume one contract moving forward for simplicity.

2. The payoff of a call option (presumably we're talking about a call here?) at expiry/exercise is max(0, S - X) so if you have a strike of 19 and the underlying is trading for 17.60, 17.60 - 19 < 0, so you would not want to exercise this option.

Let's say you're talking about puts and the intrinsic value is max(0, X - S), and 19 - 17.60 = 1.40. So if you could buy this put for .80 you could immediately exercise it for a .60 profit. I'd be a buyer.

So a couple take aways:
- don't look for arbitrage in options until you understand the no arbitrage bounds.

- For American options, here's what you need to know in the above situation:

For American puts:
P >= max(0, X - S)
For American calls:
C >= max(0, S - X)
But we know an American call is worth equal to or more than a European call, together with the fact that unless we are at expiry or interest rates are zero:
S - X*exp(-rt) > S - X

We can now improve the no arbitrage bound for the American call:
C >= max(0, S - X*exp(-rt))

It's worth noting that as a result of the second to last formula you would never want to exercise an American call on a non-dividend paying stock and would be better served to sell it because the minimum value if unexercised is greater than its intrinsic value.
 
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cjbuckley4 said:
Unfortunately, this calculation is incorrect.
1. 3x80 = 240 not 160, let's just assume one contract moving forward for simplicity.

2. The payoff of a call option (presumably we're talking about a call here?) at expiry/exercise is max(0, S - X) so if you have a strike of 19 and the underlying is trading for 17.60, 17.60 - 19 < 0, so you would not want to exercise this option.

Let's say you're talking about puts and the intrinsic value is max(0, X - S), and 19 - 17.60 = 1.40. So if you could buy this put for .80 you could immediately exercise it for a .60 profit. I'd be a buyer.

So a couple take aways:
- don't look for arbitrage in options until you understand the no arbitrage bounds.

- For American options, here's what you need to know in the above situation:

For American puts:
P >= max(0, X - S)
For American calls:
C >= max(0, S - X)
But we know an American call is worth equal to or more than a European call, together with the fact that unless we are at expiry or interest rates are zero:
S - X*exp(-rt) > S - X

We can now improve the no arbitrage bound for the American call:
C >= max(0, S - X*exp(-rt))

It's worth noting that as a result of the second to last formula you would never want to exercise an American call on a non-dividend paying stock and would be better served to sell it because the minimum value if unexercised is greater than its intrinsic value.
More...

I'm talking about a put option.

And you are right, 3 x 80 =240.

But still then, here it would be a profitable trade I think?
 
Here is your problem. You are suggesting that you can buy the 19 strike put with the stock at 17.60 for .80. Yes if you could do that you would make an immediate profit. The problem is that this won't happen. The put has an intrinsic value of 1.40 so you won't buy it at .80.
 
FSU said:
Here is your problem. You are suggesting that you can buy the 19 strike put with the stock at 17.60 for .80. Yes if you could do that you would make an immediate profit. The problem is that this won't happen. The put has an intrinsic value of 1.40 so you won't buy it at .80.
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And what if I can buy it at that ask price, I make an immediate profit?
 
stockoptionstrader said:
And what if I can buy it at that ask price, I make an immediate profit?
More...

Yes, you could make an immediate profit by buying the stock and exercising the put. But this won't happen. You might as well be asking if you go to your bank and buy a $20 bill for $10 will I make money? If you are seeing this price, it is wrong, perhaps stale, or a last price.

Things don't work this way.
 
What @FSU says... you won't be able to buy that put. The intrinsic value is 19-17.60 = 1.40....
I seriously doubt that .80 offer is there... are you looking at Yahoo prices?
 
cjbuckley4 said:
It's worth noting that as a result of the second to last formula you would never want to exercise an American call on a non-dividend paying stock and would be better served to sell it because the minimum value if unexercised is greater than its intrinsic value.
More...

In the United States, long equity options have a 100% margin requirement, which can be more than the margin requirement resulting from exercise, creating an incentive to exercise. I tried this experiment recently, selling a deep in the money call on a spiky ETF that does not issue dividends. I was assigned early when the price increased substantially.
 
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toonerdy said:
In the United States, long equity options have a 100% margin requirement, which can be more than the margin requirement resulting from exercise, creating an incentive to exercise. I tried this experiment recently, selling a deep in the money call on a spiky ETF that does not issue dividends. I was assigned early when the price increased substantially.
More...

Exercising long calls early doesn't have anything to do with margin requirements. Maybe you got lucky, but to say it's because of margin reqs are an incentive to exercise is just silly...

What ETF was that? It has probably more to do with short rates in underlying...
 
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