Since we are selling call and put options we know there are traders or market makers who are buying them. In this article we will explore why only about 10% of all call options are actually exercised by the option holders even when the holders want to own the underlying shares.
Why are call options purchased?
The main reason for buying call options is to take advantage of share appreciation of the underlying security. Options cost less than do the shares and so options can be leveraged to result in a higher percentage return. Because of the time value erosion of options (Theta), the expectation of call option buyers is that Delta (rise in share price) will overcome the negative impact of Theta (from the call buyer’s perspective) resulting in a significant profit.
Another reason portfolio managers buy call options is to move to a Delta-neutral position to mitigate “market risk” If a portfolio is short stock we have negative Deltas. Buying call options (positive Deltas) will move to a more Delta-neutral position.
Finally, call buyers may actually want to own the underlying shares. In this circumstance it usually still does not make sense to exercise. Let’s explore why.
Real-life example: ALGN
At the time I am writing this article at the end of May, 2016, Align Technology (ALGN) has been on our Premium Member Stock Report Running List (and my personal portfolio as well) for multiple weeks. Here is a screenshot of the options chain for the call contracts expiring June 17, 2016:
Option buyer’s alternatives
The assumption is that the call holder wants to own the underlying shares:
1- Exercise the in-the-money $75.00 call option
All in-the-money strikes have an intrinsic value component to the option premium which means that there is an “exercise-advantage” to the call holder. In the case, the shares can be purchased for $75.00, a $2.43 “discount” from current market value. So far, exercise seems like a good choice. However…
2- Sell the option and then buy the shares at current market value
The bid column shows that the options can be sold at $3.40. Then stock shares can be purchased at the market price of $77.43 resulting in a debit of $74.03, less than the $75.00 in choice #1. The option holder benefits by $97.00 per contract by not exercising the options. This is because exercise will leave time value on the table, capturing only the intrinsic value of the option premiums.
Many option traders believe in the myth that 70 – 90% of all options expire worthless. This is not true. More accurately, only about 10% are actually exercised, 70% are closed while about 20% expire worthless. This article reflects one of the reasons why in-the-money call options are not routinely exercised.
***Thanks to Jason L. for inspiring this article.
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September 29th, 2016
9 PM ET
Blue Hour webinar 2: “Using Put Options to Buy and Sell Stock”
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Cost: $29.99 (premium members register from the premium site for free)
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Blue Hour 2: Using Put Options to Buy and Sell Stock (new presentation)
- Fundamental analysis
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Real-life example: Starbucks (SBUX)
Brokerage levels of trading approval
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October 17th, 2016 (originally 10/24)
November 5, 2016
Plainview, New York
Saturday morning 3-hour workshop at the Plainview Holiday Inn. I am the only speaker and plan an information-packed presentation covering 5 actionable ways to make money or buy a stock at a discount using both call and put options. We will also evaluate the stocks you currently own for option-selling.
December 6, 2016
Options Industry Council Webinar Summit
Tuesday afternoon…information to follow:
Global stocks strengthened this week following critical meetings of Bank of Japan and US Federal Reserve rate-setters. The market reacted positively to the BOJ’s policy shift and the Fed’s signal that tightening is likely later this year. Volatility declined with the Chicago Board Options Exchange Volatility Index (VIX) dropping to 12.29 from 17 last week. Oil prices rose to $46.25 per barrel from $42.80 a week ago. This week’s reports and international news of importance:
- The Federal Open Market Committee, the Federal Reserve’s rate-setting body, said the case for a hike in the federal funds rate is strengthening, the clearest indication to date that it hopes to hike rates by the end of 2016
- While signaling that a rate hike is likely in the months ahead, Fed officials lowered their economic growth forecast and trimmed the number of rate hikes they foresee in 2017 from three to two
- The Bank of Japan altered its policy mix. Previously, the BOJ had focused on expanding the money supply to spur economic growth and inflation. After not having had much success on either front, the bank this week adopted an interest rate target. Going forward, it will seek to keep the 10-year Japanese government bond yield at around zero
- Bond issuance around the world is running at its fastest pace since 2007. A total of $4.88 trillion of debt has been sold globally year to date, nearly matching the $4.91 trillion sold in the same period of 2007. Super-low borrowing rates are spurring companies to lock in cheap financing, and in some cases issue debt in order to buy back shares or pay dividends
- Excessive credit growth in China risks a banking crisis in the next three years, according to a report from the Bank for International Settlements
- The weak global economy will persist into 2017, according to the Organization for Economic Co-Operation and Development, predicting that global gross domestic product will rise an anemic 2.9% this year and 3.2% next year. Brexit impacts offset gradual improvement in emerging market commodity-producing economies, according to the OECD
- Real estate was launched as its own sector by Standard and Poor’s this week, the first addition to the lineup since 1999. Previously, real estate–linked equities were part of the financial sector. Many of the companies in the sector are real estate investment trusts
- US existing homes sales dipped 0.9% in August versus economists’ expectations for a 1.1% rise. The National Association of Realtors attributes the drop to tight inventories. There is a 4.6 month supply on the market at the present sales rate, below the 6 month supply that realtors deem a healthy balance between supply and demand
- The median house price rose 5.1% to $240,000 in August from a year ago
THE WEEK AHEAD
- ECB President Mario Draghi testifies before the European Parliament’s Committee on Economic and Monetary Affairs on Monday, September 26th
- Oil ministers from OPEC gather in Algiers to discuss a production freeze from Monday, 26 September to Wednesday, September 28th
- Fed chair Janet Yellen testifies before the House Financial Services Committee on Wednesday, September 28th
- Yellen speaks at a Kansas City Fed forum on Thursday, September 29th
- The US fiscal year ends on Friday, September 30th, necessitating quick congressional action to keep the government open
- Revised 2nd quarter US GDP data are released on Thursday, September 29th
For the week, the S&P 500 rose by 1.19% for a year-to-date return of +5.91%.
IBD: Market in a confirmed uptrend
GMI: 5/6- Buy signal since market close of September 22, 2016
BCI: My positions for the October contracts favor in-the-money strikes 2-to-1
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
Alan ([email protected])