Dear Mark, Hello Juan,
I think I was given bad advice recently. I was long a put option on the MCSI i shares EEM. The option on the date of expiration was in well deep in the money. My broker called and told me that I had to sell the options or exercise them, before the market closed. It's true that you may have been forced to sell, but there is no reason why you should have been forced to exercise. There has been some miscommunication, or your broker made a mistake. Why could you be forced to sell?
If you own this option in a retirement account, you are not allowed to own a short stock, ETF (or call) position in a retirement account (at least not in the US). Thus, you would be forced to close the position on expiration day, or sooner.
It's also possible that your account does not have permission to carry short positions. If that's true, then your broker did not make a mistake.
It's also possible that you lacked the capital to meet the margin requirments for a short position. By closing on expiration day, you are prevented from owning a position when you cannot meet margin requirments. If this is the case, then your broker did you a favor by letting you know in advance.
I was just waiting for the option to expire and pocket the difference between the market price at expiration and the strike of my option. After all I have the option to exercise NOT the obligation right? I was told that there is a rule in the US that states that all options that are more than 0.50 cents in the money must be exercised.
True, but there is an exception to this when expiration arrives: What your broker was trying to tell you is that any option that finishes at least $0.05 (not $0.50) in the money is automatically exercised. That part is true. But what you weren't told is that you have the right (not that you would want to do it, but have the choice) to notify your broker NOT TO EXERCISE. That means you always have the right to allow an ITM option to expire worthless. You would do that only if the option is ITM by a very small amount. Obviously, you would NOT do that with an option that is deep ITM.
And if I am forced to sell before expiration, even during the last trading day, It costs me on commissions and potentially forgone profit if the stock falls even more after I close my position. Yes, if you sell and the market drops you lose out on potential profits. Your broker may charge you more for an exercise than he charges to sell. Thus, it's not certain if it would cost you more in commissions. But you are mistaken about being forced to exercise. You can exercise an option during the day (but as a customer, you would never have any reason to do so) - yes, you can submit the exercise instructions during the day, but the price (which is your concern) is determined by the settlement price of the underlying - and that's expiration day's closing price, not the price at the time you exercise.
But, these are NOT EUROPEAN options. You do not get the intrinsic value of the option in cash. No matter what the price of the underlying, when you exercise these puts, your position (after an exercise) is short that underlying. You are paid the strike price for the sale, but that's true no matter how deep ITM the underlying is. You may be confused with cash-settled European style options. ETFs are American style and are settled in shares, not cash.
"If you do nothing", I was told, "you will wake up on Monday with a big short position." True, but if you exercise earlier, you have the same result. Thus, your broker is confused here.
I would appreciate your comments. I hope this helps.
Best Regards, And mine to you, Mark
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