Stock Options - Exercise or Sell to Close?

Question:

Someone purchased 170 Call options for $20,000 a month ago at $1.10/contract with a January expiration (TODAY), and the options price today is only at $.60/contract. If this person sells at $.60/contract he loses about $9,500. HOWEVER, the stock price is actually "in the money" at present ($73.70 right now) and the Call was for only $73.00. However, to exercise all 170 contracts (x100 shares each contract equals 17,000 shares of stock at a price of $70.00 each equals $1,190,000) he would need to actually purchase that many shares for that amount. This person does not have $1.19M in his account. QUESTION: Would it not be possible to let his brokerage auto execute these shares tonight and then this guy could turn around and sell them all on Monday morning to cover the expense? (Assuming the stock price closes at or near the current $73.70.share and he would be assigned them for only $70.00/share?). What am I missing in this scenario? Is this possible?

Answer:
Standard answer, right out of the books: "it is never optimal to exercise a call option on a nondividend-paying stock before expiration time" (ie., no dividend paid during the remaining life of the option).

It is better to sell-to-close the 170 option contracts than to exercise those options and buy the 17,000 shares and then sell them on Monday - even assuming that the person has the margin or purchasing power to cover the $1.19 million - the transaction costs (and margin interest charges) would much likely be significantly higher on the 17,000 shares than on the 170 option contracts.

And the brokerage would not just auto-exercise the options and then let the person sell those shares on Monday - that would, in effect, be the brokerage loaning 1.19 million dollars to the person, which is something that the brokerage just would NOT do (unless he had the margin power to do it). The brokerage would just break the trade instead, and the call options would effectively expire worthless (in which case, he would lose 100% rather than 53%).

Plus, there is always the "surprise factor" in carrying the stock shares over the weekend for Monday-sale - what if some bad news occurred over the weekend; all of a sudden, what was a small ($10,500 or 53%) loss on the option contracts could turn into a very LARGE loss on the stock shares. Okay, some good news could happen instead - see previous paragraph on why the brokerage wouldn't let it happen anyway.

You'd need to have margin buying power equal to the $1.2MM (generally half of that amount in stock and/or cash in your account). Otherwise the broker can't buy the shares for you. You'd likely get nothing out of this strategy. Just close out your position.

Have you taken into consideration the transaction costs that is the brokerage charged and the interest? I think it should not be significantly in the money, if at all it would be, if we include those two.

Stock Options - Exercise or Sell to Close?

Hot Topic