From the May 01, 2012 issue of Futures Magazine • Subscribe!

Trading early exercise options on the OEX index

It’s never too early for (OEX) exercise

Practical example

Let’s assume that you owned a riskless position known as a “box.” An options box position is the simultaneous ownership of a long call spread and long put spread sharing the same strikes. Another way to look at the box is owning long synthetic stock at one strike and being short synthetic stock at a higher strike. If we were to own the 625-635 box, it would mean that we own the 625-635 call spread and the 635-625 put spread (see “Spread breakdown,” above).

  • The first table in “Spread breakdown” shows that we will exercise our long 625 call because it is a call exercise, and it is the only call that is deep in-the-money (ITM).
  • Once the call is exercised, it will be closed out at the cash price of $637.31, as shown in the second table. This will change the position dramatically because this call is almost a 100 delta option and the corresponding put (625 put) is almost worthless.
  • See the third table. Because the 625 call was exercised and its corresponding put has almost no statistical chance of expiring ITM with only one day remaining, we need not concern ourselves with this strike anymore (for now). Instead, we will have to close out the remaining short synthetic stock at the 635 strike via buying the equivalent amount of short synthetic stock we are exercising. In this example, it is one contract. We will purchase one contract of the 635 call and sell one contract of the 635 put to close out the position. Note: Most traders will trade the most liquid contract, so they will trade the at-the-money strike. It just so happens that the ATM strike was part of the box we had in position. Recall from above that we bought the synthetic stock for $636.35.
  • As we can see in the fourth table, after closing out the 635 strike by buying synthetic stock, we noticed that all the positions were gone with the exception of the 625 put. Though it has a small statistical chance of ever being worth anything by the end of the following day (expiration), it should be bought back nonetheless. We do not want to give back all of our profits (and possibly more) simply because we were too cheap to purchase an 18¢ option.

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