A friend of mine sold the TSLA weekly $347.50 call and collected $2.49 per contract last Friday - furthermore the call is naked.
He is saying that the party that bought the contract from him will only exercise the option contract if price is above the strike plus the premium paid. I’m having a hard time convincing him that as long as the option expires in the money there’s a strong chance someone is going to call 100 shares of TSLA away from him.
I tried explaining that the premium was a sunk cost to the contract holder and that my friend bears the open market cost liability.
why would someone not exercise a weekly call to buy 100 shares of TSLA at an agreed upon $347.50 price when the price closes at let’s say $349.00.
I feel like I understand options pretty darn well… but I failed L2 in band 10 so obviously I can’t be trusted.
usually people dont exercise calls at all. they just collect at the end if there is value. brokerage usually auto exercise at expiration if you do nothing and there is value. all options have value no matter how otm and itm, there is always a premium. but the premium declines as you go further itm. the further you go itm, the further it trades like a stock, but with leverage since you didnt really utilize that much capital.
selling naked typically a bad idea on bubble stocks like tsla. just fyi
Didn’t answer the question at all though? You admitted that brokerages will auto exercise if there is value at expiration. So question still stands of, if someone paid $2.49 per contract for a $347.50 strike, and price is $349 at expiration, why would the broker not auto exercise? There’s obviously $1.50 of value left in the contract.
opps sorry was about to add to my post. anyways its cuz its much easier to sell/buy call to close position vs exercising collecting the stock then selling the stock or vice versa buying stock/ delivering. exercising really just happens at the end. which is why us calls are practically similar to euro call. most ppl just exercise at the end.
also if you do exercise before expiration. you are basically giving up the premium which is a retarded move.
Whether it ends up getting exercised or not shouldn’t really matter from a P/L perspective on expiration day (transaction/brokerage costs aside). At $349 it very well may be exercised, but because of the $2.49 premium collected on sale, he’s technically still in the green and will remain so unless the stock closes above the strike + premium = $349.99. Now the real risk he bears is being exercised on Friday afternoon and being forced to hold the short position in TSLA (presuming he holds no position in the underlying) over the weekend and the risk that TSLA may open above (well above?) the Friday close forcing him to cover at higher prices and realizing a loss on the position.
Right, I understand. But the only question lies around the option being exercised or not. For the record I’m talking about the weekly that expires tomorrow. and so long as it’s in the money (by any margin), it should be exercised given the value it has to someone (the broker being last on the list).
It may or may not be exercised, but I’m not 100% sure on that. It ultimately depends on what incentive the long call holder has to exercise (e.g., they purchased the call for less than $1.50). I’m guessing it may be worthwhile to chat with the broker about this.
Let’s say the stock closes tomorrow at a theoretical $349.00. He is saying that the total cost to the option holder to exercise would be $34,999.00 (100 * 349.00 + 249). whereas in the open market it would only cost $34,900.00 to buy 100 shares. I then explained that adding the 249 onto the first calculation is in error since that is not a cost ot exercising the option, it’s only the cost of buying the contract and the option holder in this example is out the $249.00 regardless if he exercises or buys at $349 (which would then bring the total cost to $35,149.00.
So the option holder (long party) isn’t going to be transacting at $349 ever if they exercise… they’re transacting at their strike price of $347.50. That math up there is wrong.
The long option holder purchased a right to buy TSLA at $347.50, a right which cost them $2.49.
Whether or not they exercise, the long option holder is in the whole $2.49 with the position.
If they exercise, they’re in the whole for $347.50 and the $2.49 they paid to reserve the right to buy at that price. Their breakeven price can be thought of as the sum of those two, or $349.99.
From a breakeven price point of view, exercising the call option would be more favorable than simply buying the shares outright at $349. The reason is that at $349, that long call option has intrinsic value worth $1.50 which would only be captured if the option were exercised or sold back to the market just prior to expiration.
OP, ignore everything posted before me. It’s a lot of people trying to be smart but who don’t know anything. You will almost definitely want to exercise an expiring call option if the stock price is materially above the strike price. The initial premium you paid is irrelevant to this decision. In fact, the exchange will automatically exercise your position if you are in-the-money by 1 cent.
I said “almost definitely” because there are some exceptions that probably don’t apply to you. For instance, if you are a dealer who is delta hedging, the option is barely in-the-money, and you find yourself with other long stock for whatever reason, you might choose to not call the stock to remain delta neutral. You will need to call the exchange (or have your broker call the exchange) to tell them not to exercise in this case.
Also, Nerdy, you will want to early exercise call options on discrete dividend paying stocks under certain circumstances. In particular, you will exercise the call option the day before a dividend ex-date if the dividend payment times roughly the option’s delta exceeds the extrinsic value. You will lose the optionality, but not lose the more meaningful intrinsic value of the dividend. You could sell the option, but this effect will be largely priced in. Incidentally, you can prove mathematically that early exercise is never optimal for stocks with continuous dividends, but that’s just theoretical.
As usual you certainly appear to be more knowledgeable about this topic, and I’m sure the OP will appreciate your insightful response as I surely did. This extra virtual jab you decided to include though adds nothing and if anything gives the others on the forum some indication of how insignificant/discontent you must feel in your real life.