Another question
Mark I read this online-- (you wrote this)

There is an important point that must be mentioned. When you buy the stock @ $42.74, then the intrinsic value of the Jun 35 call is $7.74 and selling for only $7.50 is a foolish thing to do. As you indicated in your discussion above, the most likely outcome for this trade is losing $24 per 100 shares - and that loss occurs because that call option was sold below parity (below its intrinsic value). If you were to get $7.75 for the call, then you would have a tiny (very tiny) chance of not being assigned an exercise notice - and if you were assigned early, you loss would be only the commissions you paid to trade. But when you sell at 24 cents under parity, it's just a bad trade.

How did you figure that our so quickly and how is that determined (what are the equations??)

Thanks Don

Hi Don,

1) There is zero (not a tiny) chance that a deep in the money option is not going to be exercised and that you may 'slide' by not being assigned an exercise notice. The current rule stipulates that all options that are in the money by 5 cents or more are automatically exercised, unless the call owner issues specific instructions to his broker 'not to exercise.'

2) The price at which you sell an option has absolutely ZERO to do with whether you will be assigned an exercise notice. Some people mistakenly believe that a call owner may not exercise an option if he has a loss. Not exercising only makes the loss much larger. If the stock is 36 when expiration arrives, the call is only worth a buck and the call owner may lose $6.65. But, he still exercises. Why throw away that last dollar?

3) Unless there is a dividend, the chances of being assigned early are slim.

4) When you own stock, you have cash tied up. Cash that could be earning interest. thus, the losses are even greater than you mention.

5) There is not much to the equation. When an option is ITM, the amount by which it's ITM is the intrinsic value. Thus, subtract strike price from stock price. In the example you used, 42.74 minus 35 is 7.74. If you choose to sell this option, you must collect at least: $7.74, plus enough cash to pay the interest cost of holding the stock through expiration, plus some additional premium (your profit potential) to make the trade worth doing. And don't forget the commission cost.


Mark D. Wolfinger
Create Your Own Hedge Fund: Increase Profits and Reduce Risk with ETFs & Options