Holding Options Through Expiration | Options Trading Concepts

[Music] [Music] hey everyone welcome back to the show thanks for tuning in my name is Mike this is my whiteboard and if you're brand new to this show this is a show where we take concepts we break them down and we build them up visually for you so today we're going to talk about holding an option through expiration last Friday was the standard monthly expiration for April but we're going to talk about today is going to apply to all the explorations at whether they expire on a Friday which is normal equities or maybe a different day if we're looking at something like SPX or the VIX all these are going to apply and we're going to talk about the difference between holding an option that's in the money through expiration and letting it expire to stock versus closing out that option and maybe buying stock or doing something to synthetically replicate what would happen if we just held it through expiration we're going to talk about a few factors that differentiate the two so let's talk about our first trade we'll just create a hypothetical scenario where we're selling a put here and we're just looking for our standard 45 day until expiration selling and out of the money put so here we've got the stock price trading at 50 and we're looking to sell and out of the money put at 45 and we're gonna collect about a dollar for it in this example now as the trade goes on let's say 45 days have gone by the stock price swayed up and down a little bit but it ended up going to 43 at expiration we've got zero days left so let's say this is a regular equity trading vehicle so we're looking at a Friday so we're on Friday expiration we've got just until the market closed to trade this and the stock price is at 43 and we've got our short put at 45 well the very first thing we need to do is calculate our P&L on this trade well if I know that at expiration this option is going to be trading for intrinsic value or very close to intrinsic value in this example we're going to assume that it's training for purely intrinsic value so I know that if I have a short point at 45 which gives me the right to become long shares at 45 and the stock prices at 43 this in the money put is going to have intrinsic value of $200 it's it's two points in the money as you can see the stock prices at 43 and our short point is at 45 so we're gonna see a theoretical loss on this trade of $200 however I did collect one hundred dollars or one dollar at the beginning of this trade which I can use to offset those losses so even though I would have to purchase this put back for about two dollars or two hundred dollars at expiration because there's no time value left in that option there's no extrinsic value I do know that I originally collected a dollar so I can use that dollar to offset that payment that I'd have to purchase this put back for to give me a P&L of negative $100 so in any case this would be a losing trade of 100 dollars but there's a few things that I can do if I want to become long stock so the very first thing I can do is hold this option through expiration if we're dealing with TD Ameritrade they'll automatically exercise the option and we'll become long stock at 45 so on the next slide we're gonna break down exactly what would happen if we were to do that so if we let it expire and we hold it through expiration on Friday on Monday we would come back to our portfolio and we would be long 100 shares there's a few things to note about that though so if we let it expire we have the right to buy shares at 45 so what we're gonna see is we're gonna see our long shares at 4500 dollars or it's gonna it's going to show us a cost of forty five hundred dollars to become along these shares because we're looking at that strike of 45 so we're gonna see the long shares at 45 but we have to remember that our breakeven is at 44 all we have to do to calculate our breakeven is just look at the strike that we're dealing with so in this case the short 45 put option and we subtract the credit we received from that strike to determine the breakeven so since I collect dollar I would be looking to look at that 45 strike and then subtract $1 from that to determine my breakeven now one thing that's really important to realize is that we're probably going to see a $200 loss on these shares because we're long shares at 45 now and the stock price is at 43 we will probably see a loss of $200 on the portfolio but we have to remember that we did collect $1 at at the beginning of the trade so our real P&L is negative $100 even when the stock price is at 43 where we're $200 in the money so we do need to realize our breakevens at 44 and in this situation we're going to be long shares at 45 the stock price is going to be at 43 so we're probably going to see a $200 loss but we know that if the stock price goes up to 44 where we see a $100 loss on this trade or a gross loss of $100 we do know that that's where our breakeven is because of that original collection so it's important to realize where our breakeven is while we're placing these trades because the portfolio page on any platform especially when we're long shares at 45 and the stock price is at 43 it's going to show us something different than what is reality so if I know my break evens at 44 even if the stock price comes to 44 I'm probably still gonna see a P&L loss of $100 on that trade but I know that it's a break-even because of that credit I collected originally now here's another important factor and when we're talking with TD Ameritrade here and you have if you have the dough rates with TD Ameritrade the there is an exercise fee per leg of $15 so if I were to let this option expire in the money it's going to automatically exercise and turn into long 100 shares of stock but there is a 15 dollar fee to do so so what is one thing we can do to potentially avoid that $15 per leg fee and it's important to realize that it's per leg not per contract so I could I could have a 10 lot on this 45 strike which just means I'm selling 10 puts instead of just selling one and I would just get charged at flat rate of $15 if this was a put spread however where maybe I had a long put at 44 and my short put at 45 I would have a $15 charge per leg so I would have a $15 charge on that long leg at 44 and a $15 charge on the short leg at 45 regardless of how many contracts I'm trading it is a per leg basis so that's important to realize but again what can we do to potentially offset that well we're going to talk about that on the next slide here where we're looking to close that position and just buy the shares outright so if we were to close the put which would just be buying it back and then buy the shares at the market price we can get that same result so at the end of the day we would still be long 100 shares and our put would be closed so let's talk through what would happen there well very first thing we need to do is buy back that put so we would buy that back buy that put back for $200 since it's trading for $200 of intrinsic value right at expiration and that's going to cost us a dollar fifty per option contract when we're looking at the dough rates with TD Ameritrade so if I have to pay a dollar fifty per option contract to close my position that's great I'm fine with that now what I'd have to do to replicate that same scenario is buy the shares so instead of owning the shares at forty five now I would go out into the market and buy those shares at forty three and with those say that same commission structure we're looking at a seven dollar flat rate for share purchases so right away we're looking at commissions of eight dollars and fifty cents rather than that exercise fee of 15 dollars so maybe this option would be a little better one thing that we need to realize though is that we do have the long shares at 43 so in this trade we're going to see a P&L of zero because really I'm closing out my long put so that's going to be off my portfolio page and I'm buying shares at the market price of 43 so it's not going to consider any of the previous actions that I took it's just going to show me my new shares at 43 and that's something we need to remember because we're buying shares at 43 our breakeven is still going to be the same at 44 but if the shares come from 43 to 44 what we're gonna see is a profit of $100 but we know that that's not really the case because of my previous position where I had a P&L of negative $100 if I buy the shares at 43 and they come up to 44 my portfolio page is going to show me a P&L of positive $100 but if I'm looking at the analyze page on the dough platform where I'm looking at the order chains which keeps track of all the rolling and closing trades that I do which is an awesome awesome feature if you haven't checked it out yet that's going to show me my break even my real break-even point which is at 44 so these are a couple of ways to visualize and really see what's going on in the platform the portfolio pages might show you one thing because it's only keeping track of the new traits and the current trades you have on but it's important to realize that even when we're dealing with situations like this where I'm entering in this new trade where I'm buying shares at 43 and I have a negative $100 loss on the previous position if the stock shares go up to 44 on the portfolio page I'll show a profit of $100 but that's not really the case because I know my breakeven was at 44 in the previous example so these are two different ways to potentially hold an option through expiration and either be assigned the shares by letting that leg exercise or synthetically close that situation and become long the shares in another way so this one we looked at closing that long put and buying the shares where in the previous example we looked at just letting those shares exercise and you can see that the two different scenarios do give you a few different results in terms of what you'll see next on the portfolio page but let's wrap all this up with some takeaways for you so the very first takeaway here is that the more extrinsic value there is in the option the more inclined I will be to avoid exercising so this is a hidden gem and a really good piece of information and this is how I think of it when I look at exercise and assignment risk so the more extrinsic value there is in option the more inclined I will be to avoid exercising and that's especially true if I'm short an option so if I'm short an option and there's a lot of extrinsic value in that option left I don't feel any risk at all in terms of personal risk of being assigned I know that the counterparty on the other side is long that option in some sort of way and I assume that they're aware of that extrinsic value if they exercise that option they lose all of that extrinsic value so let's say that same option that we talked about that was $2.00 in the money also had 50 Cent's of extrinsic value so if my option was in the money and let's say there was 10 days left to go and my option was in the money there's 50 cents left of extrinsic value if I'm assigned on that put that person actually just did me a favor because if I was waiting for that extrinsic value to come out of that option before I close the position to further reduce my cost basis if they assign that option early they give up that extrinsic value because shares our shares there's no extrinsic value in shares so if they were long that put in that example and they exercise their right to sell those shares to me I would now be long those shares at the strike price and the extrinsic value would have got what have disappeared so I would have been able to buy back those shares at the intrinsic value and basically what they're doing is giving up that extrinsic value and they're giving it to me in terms of cost basis reduction so whenever I'm assigned early very early on an option I actually look at it as them doing me a favor because they're giving up that extrinsic value and I'm able to use that extrinsic value that I originally sold to use as cost basis reduction so it's an interesting way to think about it but that's how I think about it when I look at assignment risk I look at where the extrinsic value is if it's very low then I might feel much more inclined to roll in my position or close it because I would probably be assigned but if it's there's a lot of extrinsic value there I don't really feel at risk personally secondly we do need to consider commissions and fees when we're looking at these scenarios you saw that with the current structure with TD Ameritrade the very first situation where we let it spire almost doubled the Commission cost as if we were to just close that put and buy the shares so depending on what brokerage you're using it's really important to see what the fees would be and what would be best for you and lastly be cognizant of the break-even going into the new trade the portfolio in all of these trader trade platforms are only going to show you the newest the newest strategy and the newest position you have on so depending on how you got into that position one might show you a loss of $200 like we saw here and one might show you a P&L of zero and even if we got up to our breakeven that portfolio page would show you a profit we're really we're just breaking even so it's important to really understand your breakeven prices going into that new trade so thanks so much for tuning in hopefully you enjoyed this segment my name is Mike if you've got any questions or feedback shoot the should be an email at one of these here or you could follow me at doe trader Mike on Twitter stay tuned them we've got Jim Schultz coming up next with from theory to practice you

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Keywords: trading, trader, stock, market, finance, learn to trade, beginner trader, options, options trading, tastytrade, profit, trading tutorial, investing, how to trade, expiration, option expiration, option trading for beginners, long calls, long puts, short calls, short puts

Id: yqIgnMGzSTU

Length: 14min 32sec (872 seconds)

Published: Thu Sep 07 2017