Trading expiring options can be a challenge. There is a finality to when that bell rings at 3 pm on Friday. It is either going to become underlying stock or it simply goes away. It can cause a lot of anxiety for new traders (and perhaps some seasoned ones) if they do not properly assess their risk.
Let’s take a hypothetical example:
Let’s say you were playing Gilead Sciences (Ticker: GILD) for their earnings report this morning. GILD closed at $65.33 yesterday before the report. Let’s say our assumption was that GILD was going to stay rangebound and we decided to do an iron condor to take advantage of this assumption.
Here is one example of what you could put on:
As it turned out, GILD moved more than the expected move to trade approximately $67.50 at midday Friday.
Now, you put on your risk manager hat. Essentially, from a statistical standpoint, you can forget about the put side of this iron condor. It’s too far out of the money and is essentially worthless. That leaves the call side. You are short the expiring 5/3 66/67 call spread from $0.50. You have blown through all of your call strikes and if we were to expire here, the spread would max out at $1.00 and your next loss would be that $1.00 less the $0.50 collected in the initial premium or a loss of $0.50. In this case, settling above $67.00 you would be assigned your short 67 calls and would exercise your 66 calls. The stock position would be a loss.
At any time during the trading day on Friday, you could buy the call spread back. The most the spread can trade is $1.00 or less if there is still extrinsic value in the 67 put.
The issue comes if we fall back below 67. Then you have a call that is in the money that you will most likely be assigned on without a call that is in the money to offset it. This is not necessarily a bad thing because the spread that you are short will now be worth less and you can realize less of a loss or even make money.
It’s just important to know where you stand and what your “options” are.
Follow me on Twitter: @MikeShorrCBOT
