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Mark Wolfinger fields a question about options exercisevs. other ways to exit a trade
Trader Networkregular treeHamster posed an all-too-common question about options exercise andthe bigger question of how best to exit an optionsposition. treeHamster writes:
I have 32 contracts of MU calls at a strike of $5.00. Iknow if I were to exercise the contracts it gives me the right to buy 3200shares at $5.00 each, but what if I don't have that much cash in my account?What can I do with the contracts?
I wonder this as when the expiration date comes how much of a cut will I haveto take to sell of the contracts, if for example the underlying at that pointwas $6.00 giving a $1.00 profit/share. Sorry I'm just new to options and wishto know.
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Let’scorrect some facts, just to help you better understand this situation you'rein:
1) As a long call owner, you already have the right to buy 3,200shares @ $5
2) Exercising the options completes the transaction. In other words, exercisingyour call options means that you are committed to exchanging your options forstock and paying $5 per share for it.
3) If the stock is currently $6, you do NOT have a PROFIT of $1 per share. Yourcalls would be worth $100 apiece. But to determine the profit, you must subtractthe cost and commissions before you actually clear a profit. At TradeKing thecommission to exercise your 32 calls would be $9.95.
Next, theseare the questions you must be asking beforeyou make any trades. Not after. In this case, there is no harm done with adelayed reply.
A retailtrader almost never has a good reason to exercise an option. Yes, you have theright to do so, but it is usually far better to sell the options and not haveto be worried about stock or the cost of that stock.
It isalmost always a good idea for option owners to exit prior to expiration.Options are a wasting asset and decline in value every day (all else beingequal). When you bought these calls, you expected the stock price to increase.When you no longer believe the stock is moving higher, you can sell the calls.There is NO REASON to wait for an arbitrary date, such as expiration, to sell.
How much ofa "cut" you take depends on many factors, but the longer you wait,the more you can anticipate a small cut. If you sell before expiration, youwould receive (per your example above) $1.00 plus a little time premium. If youwait, you may collect only $0.95. To avoid the possibility of taking a cut, askTradeKing if you have permission to exercise the calls and weigh the pros andcons of selling the shares.
Bottomline: there's a lesson to take away from this trade. It's the same as the BoyScouts: be prepared, and ask questions in advance of trading. A lack ofplanning didn't hurt you this time around (hopefully), but that will not alwaysbe the case.
MarkWolfinger does not currently hold a position in the securities mentionedabove.
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