OPTION CALISTHENICSEARLY EXERCISE IN CALLS AND PUTS
Steve PapaleMarch 11, 2013
ARMY TRAINING SIR!
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TOPICS Exercise v Assignment American v European Options Factors Determining Early Exercise Synthetics Example Summary
WE ARE A FULL SERVICE EDUCATORST PATRICK FACTS
St. Patrick was born approximately 390 AD near Kilpatrick, Scotland
The first parade was held in Boston in 1737, not Ireland
Chicago dyes its river green each year There are more Americans of Irish origin
than there are Irish in Ireland An estimated 13 million pints of Guinness
will be consumed on the holiday
EXERCISE OR ASSIGNMENT Different side of the same coin
Holder of option “Exercises “ his right
Seller of option is “Assigned” his obligation
AMERICAN V EUROPEAN American Options can be exercised
before the expiration date. OEX, Equity Options
European Options can only be exercised on expiration date.
SPX, XEO, RUT, NDX
DETERMINING FACTORS Interest Rates Options are a leveraging instrument Rates increase – Calls go up – levering effect Puts go down – short stock effect
DIVIDENDS Lowers stock by amount of dividend
on ex-dividend day
$.25 dividend – stock will devalue by $.25 on ex – dividend day.
Price may or may not move by that amount
SYNTHETICS Options can be combined with
stock/futures to create other options.
C = P + S P = C – S -C = -P – S -P = -C + S (covered call)
EARLY EXERCISE OF PUTS Think in terms of the synthetic If we are long a put then P = C – S or P – C = S
Note: Even if you don’t have synthetics on think in terms of equations to help predict early exercise or assignments!
THANKS MR. BROWN To predict the exercise of the put look at
the call and interest we pay to carry the stock (cost of carry)
P – C = S If we exercise we must unwind entire
equation Think high school algebra If we sell put (exercise) than we buy the
call and sell the stock.
+C AND -S
If cost of call is less than the remaining cost of carry on the long stock –
EXERCISE!
THE UNWIND Our original position: +P -C +S
We would then +C -S -P (exercise)
Remember this is decision process for economically efficient exercise – you may not have all this on
EXAMPLE IBM + 10 IBM Jan 145 Puts + 1000 IBM (implied) -10 Jan 145 Calls (implied)
30 days until expiration = $.40 cost of carry for stock
NEAR EXPIRATION Assume cost of carry is now $.20
Remember we have +P +S which equals +C
If the call is trading at $.10 which is less than$.20 cost of carry we exercise put(-P) and –S and buy outright call
Result: Save $.10
EARLY EXERCISE FOR CALLS
Dictated by dividends Familiar algebra +C –P = –S Being long the call implies being short the
stock Short stock means we collect interest on
credit in the account (opposite of long stock) Note – not in most retail accounts
DIVIDEND IS THE KEY Economically, if dividend is greater
than short stock rebate than we exercise.
Most retail will exercise day before ex-dividend to capture dividend
In the money calls only
MORE STUFF Use the put as a proxy – if put is less
than dividend - exercise
Can also sell call – especially when stock too expensive to buy
Don’t do nothing – unless high interest rates
MSFT = $27 Dividend = $.23
Ex date is 2/19
Ceteris Paribas – Stock will drop by $.23 on 2/19.
All strikes with puts trading below $.23 exercise.
SUMMARY Early exercise on puts pretty easy to
predict Only on American options Interest rates and Dividends are factors Think like a market maker when trying to
predict – it’s all about the synthetic Delta will tell us – generally 90 or up We should never have to worry about being
assigned in our program
THANK YOUSteve [email protected] 800-733-6610PLE Capital Management, LLCwww.plecapitalmanagement.comsteve@plecapitalmanagement.com847-863-8272