Potential Liquidity Trap w/ Options

B

BobbyMurcerFan

What if this happens:

You buy a liquid option, let's say an at-the-money IBM 80 call.

The market keeps going up to 120. You now own what I imagine is a pretty illiquid option (b/c very few people buy calls w/ 40 points of intrinsic value).

So are you confronted with only low bids if you try to sell your call?

On the other hand, if you decided to exercise, don't you need enough equity in your account to buy IBM at 80, eventhough you plan to immediately re-sell the shares at the market?

Thanks for your help.
 
No matter how illiquid, if you are willing to give up an edge, there is an out. If "fair value" is $40.00 then perhaps the best bid will be $39.80. I have found over the years that if I'm willing to put between a nickel or dime, "locked", into a MM's pocket, they are happy to take it.
 
Originally posted by BobbyMurcerFan
What if this happens:

You buy a liquid option, let's say an at-the-money IBM 80 call.

The market keeps going up to 120. You now own what I imagine is a pretty illiquid option (b/c very few people buy calls w/ 40 points of intrinsic value).

So are you confronted with only low bids if you try to sell your call?

On the other hand, if you decided to exercise, don't you need enough equity in your account to buy IBM at 80, eventhough you plan to immediately re-sell the shares at the market?

Thanks for your help.
More...

I guarantee you that I will personally buy any option from you for its exact intrinsic value up to 3 days before its expiration. Does this solve your problem?
 
Originally posted by BobbyMurcerFan
What if this happens:

You buy a liquid option, let's say an at-the-money IBM 80 call.

The market keeps going up to 120. You now own what I imagine is a pretty illiquid option (b/c very few people buy calls w/ 40 points of intrinsic value).

So are you confronted with only low bids if you try to sell your call?

On the other hand, if you decided to exercise, don't you need enough equity in your account to buy IBM at 80, eventhough you plan to immediately re-sell the shares at the market?

Thanks for your help.
More...

If you ever really have that problem and your broker won't oblige you; email me about it, post them on ISE at parity, and I will take you out.

And, if you don't want to go through all that trouble, post them a tick below parity and I will still take you out.
 
Originally posted by BobbyMurcerFan

So are you confronted with only low bids if you try to sell your call?
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I think everybody confirmed your statement above. You will able to sell it by giving up some of your profit.
 
Originally posted by nugya


I think everybody confirmed your statement above. You will able to sell it by giving up some of your profit.
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Not exactly, I believe he was referring to giving up significant edge, multiple ticks below parity or else he would not be exercising; thereby giving up any time value remaining.
 
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