How Options Work
Q: Dear Allen,
I am pretty new to the option trading and that’s why have to ask this very basic question.
You are sometimes coming with a recommendation “Will have to hold to expiration”. I would like to get better understanding of the processes that happen at the expiration day. Could you please explain it briefly or refer me to the right place where I could find this information ?
A: On expiration we look for the closing price. This is normally the close of the day for most options, or it can be close to the opening price for index options (the final settlement price for index options is complicated). If you sold an option you know if you want the price to be above or below the closing price.
So if you sold a 50 strike naked put, you want the price to close above 50. If it does, the option expires and just goes away.
If the price is below 50, you have to buy 100 shares per option at $50 no matter what the price of the stock is.
Expiration: How Options Work
So three things can happen at expiration:
1. Your sold option expires worthless and just goes away.
2. If you sold a naked call and it expires in the money, you will have to sell 100 shares per option of the stock. If you dont have the shares, you will become ‘short” that many shares.
3. If you sold a naked put and it expires in the money, you will have to buy 100 shares per option of the stock
These three outcomes are for regular stock options. For index options, there is no stock transfer they just add or subtract money from your account in the amount the options were in the money.
Hope that helps.