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Expiration Friday Exit Strategy Decisions For In-The-Money Strikes

Covered call writing and selling cash-secured puts obligates us to buy or sell shares at the strike price by the expiration date. Exercise will generally occur if the strike is in-the-money by 4 PM ET on expiration Friday (usually the 3rd Friday of the month). Frequently we do not want to sell our shares or purchase the option holder’s shares so we buy back the option to avoid assignment. There are times when it is difficult to assess the likelihood of exercise so understanding how the process works is important to retail investors and the focus of this article.

 

How will broker manage my expired in-the-money strike?

This can vary from broker-to-broker. Our account agreement forms detail the specific procedure for our brokerage. The Options Clearing Corporation (OCC) uses a $0.01 threshold (strike in-the-money by $0.01 or more) but our broker may use a different threshold amount. Option buyers (holders) can submit instructions to the broker not to exercise even if the strike is in-the-money.

 

Exercise by exception versus automatic exercise

Exercise by exception is the administrative procedure whereby the OCC exercises all in-the-money strikes by the threshold amount unless the member submitted instructions not to exercise. This process is frequently incorrectly referred to as automatic exercise ignoring the fact that the clearing member always has the right not to exercise.

 

Control from the perspective of option buyers and sellers

Option buyers can choose to exercise in-the-money strikes by taking no action and letting the exercise by exception process move forward. They can choose not to exercise these in-the-money strikes by submitting notice to the broker to that effect.

Option sellers can avoid exercise by buying back the option prior to 4 PM ET on expiration Friday. We can remain subject to exercise by taking no action and letting exercise by exception move forward.

 

After-hours activity- how trading after 4 PM impacts exercise

After-hours trading can make option strikes move in and out-of-the-money. Some stock index options like SPY and QQQ trade through 4:15 ET but are settled based on the 4 PM close. This may result in unexpected exercise. Furthermore, professionals have an hour and a half after the 4 PM close to make a decision as whether to exercise. In addition, unexpected after-hour news like an FDA drug approval can dictate whether our options are assigned. All this behind the scenes after hour “monkey business” tells us that if we want to be sure of not getting assigned for strikes near-the-money as 4 PM approaches, we must buy back the options. A closely related topic I have written about in the past is pinning the strike.

 

Discussion

Generally, strikes that are in-the-money by $0.01 or more will be exercised. Option holders reserve the right not to exercise and option sellers can always buy back the option to avoid exercise. After-hours trading may also determine exercise for near-the-money strikes.

 

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December 1, 2016

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December 6, 2016

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February 27, 2017

Stock Trader’s Expo

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1:30 PM ET

Exhibit hall Booth 208 (February 26th – 28th) … come say hi to the BCI team

 

Market tone  

Global stocks rose this week as markets anticipated fiscal stimulus in the wake of Donald Trump’s election. Infrastructure, financial and pharmaceutical stocks were among the best performers. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), fell to 14.17 after the election outcome became clear from 21.5 a week ago. Oil prices stabilized at lower levels amid continued concerns over a potential oversupply. West Texas Intermediate crude fell to $43.90 from $44.00 a week ago while global Brent crude dipped to $45.10 from $45.50. This week’s reports and international news of importance:  

  • After the surprise victory for Republican presidential candidate Donald Trump, the market initially dropped the 5% limit in after-hours trading. Then the S&P 500 futures reversed course and closed solidly higher on Wednesday. An expected policy mix of tax cuts and increased defense and infrastructure spending, along with reductions in government red tape sent the Dow Jones Industrial Average to a record high close on Thursday
  • Growth and inflation expectations have risen since the election which keeps the central bank on course for a rate hike at its December meeting
  • Justin Trudeau, Canada’s prime minister, said that he is open to renegotiating North American Free Trade Agreement with the United States once President-elect Trump takes office in January. Canada and the US have the largest trading relationship in the world. International trade was a prime focus of the Trump campaign and shifting trade policy is a potential source of market uncertainty in the months ahead
  • Chinese trade data remained soft in October, suggesting that global demand remains subdued Exports fell 7.3% last month, while imports fell 1.4
  • OPEC’s new World Oil Outlook predicts that crude prices will not top $60 per barrel until the end of the decade, $20 per barrel below its decade-end forecast from a year ago
  • Prices for industrial metals rose sharply in anticipation of ramped up infrastructure spending under a Trump administration

 

THE WEEK AHEAD

  • Japan reports Q3 gross domestic product on Monday, November 13th
  • China releases retail sales and industrial production data on Monday, November 14th
  • The United Kingdom’s consumer price index is released on Tuesday, November 15th
  • Q3 eurozone GDP is reported on Tuesday, 15 November
  • October US retail sales data are reported on Tuesday, November 15th
  • October US industrial production data are reported on Wednesday, November 16th
  • The minutes of the October meeting of the European Central Bank’s Governing Council are released on Thursday, November 17th

For the week, the S&P 500 rose by 3.80% for a year-to-date return of +5.90%. 

Summary 

IBD: Market in confirmed uptrend

GMI: 5/6- Buy signal since market close of November 10, 2016

BCI: The surprise Republican sweep has left half of us elated and half of us frightened. As investors, we should be neither. Non-emotional investing is the key to successful investing. There will be near-term volatility in our markets initially due to the uncertainty of a Washington “outsider” leading our great country. The markets will then settle down to a norm and then we can craft our investment plan. We have so many tools at our disposal to invest defensively or aggressively depending on the statements the markets make post-election.

This challenge pales in comparison to what many of us went through in 2008. We invest in corporations that will continue to make money and that may be difficult to embrace in what many will view through a post-Brexit-like initial market volatility. From there, opportunities will present themselves.

I am currently 100% in cash and looking for the most appropriate re-entry point. Elation or fear will not be part of that decision-making equation.

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a slightly bullish outlook. In the past six months the S&P 500 was up 5% while the VIX declined by 4%.

_____________________________________________________

Wishing you the best in investing,

Alan ([email protected])

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

25 Responses to “Expiration Friday Exit Strategy Decisions For In-The-Money Strikes”

  1. Barry B November 12, 2016 10:34 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 11/11/16.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Since we are in Earnings Season, be sure to read Alan’s article,
    “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,

    Barry and The BCI Team

  2. Bill November 13, 2016 10:49 am #

    Alan,

    I see on this week’s stock list that there are many more stocks listed in bold than in previous weeks. What is the significance of this?

    Thank you.
    Bill

    • Alan Ellman November 14, 2016 7:24 am #

      Bill,

      In the summary above, I noted that the market rose by 3.80% last week. This had a positive technical impact on the fundamentally-elite stocks that passed the BCI screens and therefore there were an above-average number of stocks that were 100% bullish and confirming from a technical perspective. Bold stocks on our lists are bullish from both trend and momentum perspectives.

      Alan

  3. Marlene November 13, 2016 11:05 am #

    Alan,

    I own 300 shares of Charles Schwab and see its on your list. Do you consider the returns adequate for the December 16 contracts and which strike is best?

    Thanks for you help.

    Marlene

    • Alan Ellman November 15, 2016 7:34 am #

      Marlene,

      Yes I consider the premium returns reasonable because my target for initial returns is 2-4% per month. Others may have different initial goals See the screenshot below for initial returns as of pre-market on Tuesday. These premiums are definitely negotiable so you are seeing worst case scenario. A defensive position would be with the $36 strike and more aggressive positions with the $37 and $38 strikes.

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG

      Alan

  4. Roseann November 13, 2016 4:36 pm #

    Alan,

    I was reading an article you wrote a few years ago on mini options but haven’t seen any recent articles. As a matter of fact, I’m having trouble finding them in option chains for the 5 stocks you mentioned. Can you update us on minis?
    Thanks a lot.
    Roseann

    • Alan Ellman November 15, 2016 7:39 am #

      Roseann,

      When Minis were announced as products about to be launched, I expressed concern about the commissions brokers would charge for these options because they delivered 10, not 100, shares of the underlying. This meant that if commissions remained the same, the per-share commission cost would be 10x what it is with standard option contracts. Well brokers left commissions the same and the Mini options are now a failing product and I believe destined to failure and ultimately will be eliminated. The idea was a good one but the implementation not so much in my view.

      Alan

  5. Jay November 14, 2016 11:27 am #

    After being so wrong about how the market would react to the election it’s tough to pick myself up, dust myself off and come back to our comment board with a relevant thought :).

    I do find the “Trump Sector Rotation” fascinating. Literally overnight the market leadership turned to the Industrials, Materials and Banks. That will show up in our Premium Lists soon enough.

    I can’t recall seeing a tumble in Treasuries like this and gold related interests are no fun either. Yesterday’s “new Tech” darlings are being taken to the woodshed.

    The Dow is now “sexy” and the Nasdaq is tired. The S&P is Switzerland in all of this neutral to what is happening around it.

    In “Trump World” we will not be in Kansas anymore :).

    Stock Trader’s Almanac suggests the first year of any President’s term is usually the best for the market. So I am an optimist predicting a strong 2017. We may just have to look in different places. – Jay

    • Roni November 14, 2016 1:31 pm #

      Hi Jay,

      the market is really unpredictable, and that’s why Alan’s covered calls methodology is so good.

      His golden rule is to avoid earnings reports because you never no what the market reaction to the report will be.
      So the same goes for other major events like the election result and the market reaction to it.

      So Alan went 100% cash before the election, and is staying there until the dust settles. I am following his lead.

      What we are seeing now is a major change in expectations, and when you add the FED watch, volatility will continue to rock the boat.

      Dont give yourself a hard time. Nobody expected these changes.

      Cheers – Roni

      • Jay November 14, 2016 7:21 pm #

        Thanks Roni,

        It is always a pleasure to chat with you here and I hope others do not mind us taking up the space :)!

        I am 100% cash too. The scariest thing artists face is a blank canvass. Writer’s block happens in front of blank computer screens. Where does one begin anew?

        At least with the market we get support and resistance clues. S&P 2180 held in the Trump rally as resistance and it looks like support is 2140.

        If 2180 breaks that will be a good place to sell cash secured puts beneath the new support. If 2140 breaks it’s likely best to see how we do at the next support at 2100. That held nicely last time.

        At the moment we are in between. I am sitting on the sidelines waiting for “Coach Market” to send me in 🙂 – Jay

        • Roni November 15, 2016 1:20 pm #

          Great Jay, cash is king.

          “Coach Market” is a good indicator.
          “Coach Ellman” is my preffered model, and Barry B is sniffing the smart money trail. He observed the financial sector rotation.

          Let’s wait a little until we are sure the storm is over, and then follow our coaches..

          Roni

    • Barry B November 15, 2016 9:47 am #

      Jay,

      Interesting observation…if you take a close look at this week’s Weekly Report, you’ll notice about half of the stocks on the Running List are from the financial sector. We’re seeing sector rotation in action.

      Best,

      Barry

      • Jay November 15, 2016 12:56 pm #

        Thanks Barry,

        As you know, I am an admirer of your work!

        I suspect some Industrials will make your lists soon as well.

        XLI is the Rodney Dangerfield sector getting no respect :). Some pooh-pooh it as rust belt or boring but on a 5 year chart it has outperformed the S&P. It likely harbors some great covered call and cash secured put candidates.

        I am not protesting in the streets but count me on the disappointed side this election :), Which means I have to tune my market antennae all the finer. I appreciate your help! – Jay

  6. Bill November 14, 2016 12:19 pm #

    Hi Alan,

    I recently started doing research on options trading, particularly covered call writing. I saw one of your Youtube video’s and found it to be extremely helpful and have since read several of your books. Your advice on finding good stocks to use for covered calls, like the IBD 50 and other financial indicators has really simplified the process. However, even then a stock may begin to fall. Do you have any advice as to when to sell a stock that is starting to downtrend and your now at a net loss on the stock itself. I’ve read where some stock advisors recommend selling when the your lose hits 20% of you original price. Any advice on this?

    Thanks,
    Bill

    • Alan Ellman November 15, 2016 7:50 am #

      Bill,

      There are several tools we have available when a stock price declines. Since we are in 2 positions, it is critical to close the short options position first. Most brokerages will not allow us to close the stock position first. For the option side we have our 20/10% guidelines detailed in the exit strategy chapters of my books and DVDs. Once the short option is bought back, we can roll down to a lower strike price thereby generating additional capital, wait for a bounce back and re-sell the same option or sell the stock. I will favor the latter later in the contract when a stock is under-performing the overall market or when unexpected bad news comes out. For a specific guideline on the stock side after the short call is bought back many use 10% below the price of the stock when the position was entered.The worst thing we can do is take no action at all. I invite you to check out the exit strategy chapters for more details and specific examples.

      Alan

  7. Alan Ellman November 15, 2016 8:25 am #

    Premium members: New flow chart

    The BCI team added a new “Long-Term Investing Flow Chart” to the premium member site in the “resources/downloads” section on the right side of the page. Login to the member site and scroll down to “F”…”Flow Charts: Long-Term Investing”. This chart is the basis of our upcoming Blue Hour webinar on December 1st.

    Alan

  8. Richard November 15, 2016 11:12 am #

    Alan,

    How are BCI members choosing from the many banks on this weeks list?

    Too many to watch. And exp this Fri. I may pick a few and only 4 days to expiration

    Regards,
    Richard

    • Alan Ellman November 15, 2016 12:42 pm #

      Richard,

      Many of these bank stocks can be eliminated due to inadequate option liquidity. In the screenshot below, the red arrows point to the column that shows low liquidity displaying an “N” and shaded cells. Of the 12 bank stocks shown at the top of our most recent stock report, 8 are eliminated for this reason and 4 remain eligible. Of course, for those members using the list to simply buy and sell stock, all 12 are eligible.

      I would take all bank stocks that have adequate open interest including the ones not shown in the screenshot and insert them into the multiple tab of the Ellman Calculator and see which ones offer the returns that meet your goals.

      Other factors that some members consider:

      Which ones have the highest Risk/Reward” rankings (Scouter)
      Do they offer dividends?
      All bullish technicals (bold) ?

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG

      Alan

  9. Alan Ellman November 16, 2016 5:13 pm #

    Premium members:

    This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  10. Fred November 17, 2016 1:02 am #

    Allan,

    I was just assigned (early-11/16/16) on a covered call: FCX Call 12 strike; 11/18/16 expiration.

    I’m a bit confused as to why someone would exercise an ITM call option with no extrinsic value that doesn’t pay a dividend when they could have just sold the option for the intrinsic profit. Thoughts?

    Regards, Fred

    • Alan Ellman November 17, 2016 10:53 am #

      Fred,

      This could be simply a matter of the option holder wanting to own the stock. Since the option is trading at “parity” (all intrinsic value), there is no time value lost by exercising.

      Also, depending on the brokerage fee structure, it is possible that the option holder will pay a lower commission to exercise the option compared to closing the short call and then buying the shares.

      Early (1-day in this case) exercise not related to an ex-dividend date, is rare but when it occurs it is usually when the option is trading at parity and very close to expiration.

      Alan

  11. Adrian November 17, 2016 1:08 am #

    Alan,
    Here below is my promised long question on an indicator I hoped you had used:-
    Even though you don’t use the RSI momentum indicator in your charts, well I am but I am sometimes stuck in knowing how best to interpret whether it is bullish or bearish. If you could tell me what you think you would do, as there seem to be 2 conflicting interpretations that I know of.
    The first is that if the RSI is above 50 then it is supposed to be in the bullish range and below 50 is therefore in a bearish range.

    The other one that some trading newsletter describes is that if the RSI is going up then prices may go up(or bullish), and viceversa for RSI going down then prices may go lower(or bearish.)

    But the thing is how would you best describe the situations where the RSI is between 50 to 70 but is declining?(bullish/bearish?), – the same goes for between 30 to 50 but is advancing?(again is this likely to be bullish or bearish?)

    If you were using RSI then which of these 2 analysis methods would you say is the best to abide by? (because it seems like one method is a contradiction of the other one.)
    Thank you

    • Alan Ellman November 19, 2016 11:23 am #

      Adrian,

      As you stated I do not use the RSI indicator but understand its value. I favor the stochastic oscillator, another momentum indicator. Both are excellent at identifying overbought/oversold scenarios.

      Most chartists set overbought at “70” and oversold at “30” Some use 80/20 as I do with the stochastic oscillator. A bullish signal is when price moves above “30” and a bearish signal is when price moves below “70”

      If I did use this indicator, I would consider an ascending RSI line between 30 and 70 a bullish signal and vice-versa for a descending line.

      Let’s put this in perspective. Technical analysis is only one third of our screening process. Fundamental analysis and common sense principles are the 2 remaining category screens. Whether we use RSI, the stochastic oscillator or another momentum indicator that is only one fourth or one fifth of the technical analysis aspect or 1/12 of our entire decision-making process.

      Momentum indicators are important especially when selling 1-month options but we should never hang our hats on any one parameter. I know you are aware of this. I use the stochastic oscillator as one piece of a multi-screening process that will paint a mosaic to assist me in making my investment decisions.

      Alan

  12. Hal November 19, 2016 12:20 pm #

    Alan, in dealing with options for several years, I have kept the “.01 in the money rule” in mind, but your mention of professionals having additional time after 4:00 PM to make an exercise decision reminds me of a question I did not know the answer to: stock closes below strike price, but unusually good news comes out just after 4:00 PM Friday. The stock could be called away by professionals (or non-professionals also)?

    In relation to both calls and puts, if there is a close at the exact strike price, what happens?

    • Alan Ellman November 21, 2016 7:24 am #

      Hal,

      1- That is correct Unusually good news coming out after the bell in that time frame is possible but extremely rare. In this circumstance unexpected assignment is possible. We have no control over these scenarios other than to buy back the option whenever the strike is close-to-the-money.

      2- If the stock price closes at precisely the strike price I would buy back the option if I did want assignment. It could go either way if the option position is not closed.

      Alan

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