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Avoid The Option Expiration Rip-Off!

Posted by Pete Stolcers on February 4, 2009

In today’s option trading blog I want to try and save you some money. Have you ever been long an in-the-money (ITM) option and cursed at the Market Makers because the options were bid under parity? I have and there is a way to by-pass them altogether. This article could save you hundreds, maybe thousands of dollars.

Let’s look at an example. You are long 10 of the $50 calls and the stock is $58 x $58.10. The options are $8 in the money but the market on them is $7.80 x $8.20. You want to get out at a decent price so you try to sell them at $8. The order sits and it never gets filled. Now you get angry because you know that you are being taken advantage of. The Market Makers are in the business to make money. They figure you don’t know any better and eventually you’ll hit their bid. Here’s how to get out and keep your money.

The first thing you need to do is to find out how your brokerage firm handles this transaction. You are long calls and you can exercise your right to buy the stock at $50 – theoretically you’re long stock. If you sell the stock and exercise your calls you will be “flat”. The transaction is short exempt by rule and reg. and you have what’s called – same day substitution. This means you don’t have to put up the stock margin if it is done the same day. The brokerage firm will require advance notice of your intent to exercise. Once they have it they will create an offset that makes your account long 1000 shares.

Here’s how you handle the trade. Lets say that the stock is offered at $58.10. You place an order to sell the stock at $58.05 and you get filled. Now you exercise the call. The net affect is you bought shares at $50 and sold them at $58.05. Your net price is $8.05 which is $.25 better than the $7.80 the Market Makers were willing to give you. That’s $250 in your pocket. The Market Maker was hoping to do the reverse. First he would buy the calls for $7.80 and then he would hit the $58 bid on the stock. The end result is a quick $200 risk free profit.

If you have the margin available in your account and you are selling the stock on an uptick, you can just do the transaction without notifying the brokerage firm in advance. You do need to put in an exercise notice either verbally or through the trading application so that both sides of the trade clear and the margin is released.

This neat little trick works in reverse for put positions. It will save you a lot of money and frustration. It will also let you “work” an order using the stock which is much more liquid.

Have you ever had to deal with this rip-off? If so, share your experience with others.

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Posted in Option Intracacies - Expiration, Assignment, Volatility...

Option Trading Comments

  • On 06/09, D. Polis said:

    Why sell a large losing call position out-of-the-money one week from expiration and gain back a few measily dollars when you could hang on till the bitter end, or maybe not so bitter end, when all the action may bring more reurn than selling for peanuts at this time. I specifically refer to Pete’s advice to sell the BVF now at $.60. I know it’s a gamble, but what isn’t in this bed of sharks?

  • On 06/10, Tom said:

    I have noticed several times that deep in the money options are quoted below parity.  It seems normal to me.  I hardly know what to expect anymore when buying an option or closing a position.  Sometimes when buying i get filled on a limit order at the bid price even with a .10 spread fairly quickly with no change in prices.  Other times I put in a limit order to close a position at the ask and it sits for some time (i guess the market maker is out to lunch).  And closing a position with a large spread (above .10 ) one is at the mercy of the market maker.  It appears to me that depending on the stock some MM’s are more friendly then others.  I never blame my losses or mistakes on the MM’s but i really do believe that there is some manipulation from time to time.  Maybe it is my imagination but i don’t see how millions of transactions a day can ever be policed completely. With so much insider secrecy on Wall Street it would certainly be refreshing to discover the real truth.

  • On 08/28, Morgan said:

    I was long a AN call ,with about a month to expy. I had bought it for .30c then tried to sell for 1.00 but no takers,So i dropped my price to .30c still no takers.Then there was another offer of julyAN10 s for 1.00 after my offer of the same one for .30c! and it was snapped up. So called the 888options no @ and was told the sale was kicked out by the sec, why? he didn’t know! Morgan

  • On 08/28, Pete Stolcers said:

    In order to properly answer your question, I would need the month, strike, date and time of the order to sell. My first step would be to see if the option was in-the-money at the time.

    An out-of-the-money option is priced much differently than an in-the-money option. It does not have intrinsic value like the option in the example I provided. In the article above I’m trying to exit the position efficiently.

    The OCC (Options Clearing Corp), not the SEC would have “busted” your trade if it was filled due to an electronic error. The Market Maker on the other side gets to plead his case and demonstrate that there is no way he would have knowingly taken the otherside of the trade at that price.

    You did the right thing in calling 888.options. That is a resource you should use whenever you suspect you have been wronged.

  • On 10/20, warren yost said:

    I don’t know if I am even directing this question properly, but I am trying to overcome the bs replies from various brokers and the option trade groups. 
    How is it possible or justified that a call writer who is assigned on a Thursday or Friday will not be informed of it until it is too late to do anything other than buy shares in the open market to deliver, incurring a heavy loss?  It seems to me this should be fought vigorously.  Especially with spread positions the writer needs notice of the short leg assignment in time to exercise his long leg in order to acquire the shares at the strike price. Notice to exercise and notice of assignment should be required to be delivered by Friday morning and no later.  Am I missing something here, except the advisability to always close out spread positions before expiration?

  • On 10/22, Pete Stolcers said:

    I have just posted a reply to this question in the Option Q&A;section. “I Need To Know When I Am Assigned. Why Is Option Assigment Notification So Screwed Up?”

  • On 01/28, phil said:

    Here’s one I’ve really been trying to figure out:  Currently in the money calls on the VIX (take a look at 20-25 strikes) are trading a FEW DOLLARS below parity!  And, the March 08 calls are cheaper than the Feb 08 calls.  This is totally screwy - the obvious would be to go long and exercise except the options are European style and can’t exercise until expiration.  What’s going on here?

  • On 01/28, Pete Stolcers said:

    These options are European syle which maeans they can’t be exercised early. You can trade out of them, but you can’t exercise them. The price of the options indicates that the market believes implied volatility will decrease between now and expiration. These volatility spikes don’t normally last long and that is reflected in the price of the options.

  • On 02/04, Mark Wolfinger said:

    It’s not as complicated as you make it.

    Exercise the call first, then immediately sell long stock at the market.

    That way you don’t risk that the $58 bid will disappear while you are trying sell stock at $58.05.


  • On 02/05, Pete Stolcers said:

    You make a good point and I did not clarify my reason for wanting to sell the stock between the bid/ask. Yes you can hit the stock bid and get out at a better price than if you sold the option on the bid. However, I like to work the stock offer to try and get a better price. The option market is thin and I am always at the mercy of the Market Maker. In this case, I am able to take advantage of greater liquidity in the underlying stock. Selling an offer on a stock is relatively easy and spliting the bid/ask is almost a slam dunk. You should evaluate the size of the stock’s bid when determining if you can split the difference. If there is more stock bid than offered, you have a good chance of getting filled in the middle.

  • On 07/24, Mr. Edone Fleites said:

    I did an option trade, a put. symbol: nflx 10 sept. p 115.00 1 contract, cost $1005.00 the stock price dropped from 115 down to 6.00 that was a 9 dollar drop and only made 395.00 dollars. please tell me i was ripped off and what can i do about it!!!

  • On 07/26, Pete Stolcers said:

    When you buy an option before earnings, uncertainty is priced in. Think about it, that is why you wanted to buy the option. There was a great chance for a miss. The seller of the option demands a much higher price because he is taking a great risk by being short that option over a major news event. Once the news comes out, the uncertainty is gone and the implied volatility drops. To make money on options you buy before earnings, you need a very big move. I don’t suggest this trading strategy since it is a crap shoot.

  • On 10/18, Mr. Nagy-Deak said:

    On Friday 10/18/2010 i purchased 2 out of the money options for google at a 600 strike for .60 each.  I then issued a limit order to sell them at 1.25 each.  an hour latter i came back to my computer to find that the order had been cancled at 2:29 pm (5 minutes after i placed it) and a market order was issued to sell the stock at 3:32 pm.  they cancled my order, then waited an hour and sold it at almost the lowest possible price for the day. I can’t get any answers out of them as to what the bid and asks were during the hour after they cancled my order and sold it were, i know that when i checked them myself around 3:40 they were 1.45 and the bid and ask were higher, i think 1.50 and 1.55.  I think i got ripped off what do you think?

  • On 10/19, Pete Stolcers said:

    You talk about trading out of the money options and then you say they sold your stock. There are too many missing pieces of information for me to comment.

    Here are some words of advice. If you are trading front month options on a $600 stock a few hours before expiration - DON’T LEAVE YOUR COMPUTER, NOT EVEN TO GO TO THE BATHROOM.

    Make sure you are aware of the brokerage firms policies regarding option expiration. Specifically, how they handle auto-exercise and assignment. In their agreements that you signED, they will protect themselves in every way possible. They do not want your calls to go in the money where you are auto-exercised. The account could go debit when the stock tanks Monday and you don’t have the funds pay for the shares or cover the losses. Their risk department will cover the position whenever they want that day and via the agreements you signed, they have the right to do so.

    These employees (risk managers)are not trying to rip you off. They are trying to manage as many similar situations as they can on thousands of accounts and they will simply blow the position out. They are not trying to time the trade, they just want to get if off of their books to eliminate risk.

    As long as the options stayed out of the money, I’m not sure why they would sell the calls (you said they sold stock and I’m guessing you meant to say calls). Tey would have simply expired and there would be not risk to the firm.

    If you ever want to check time and sales, you can contact the exchanges and they will provide that to you. Try

    I don’t think you will have much recourse in this case. It is an expsive lesson and I’m sorry you had to learn it the hard way.

    Know the rules and exit front month options before the last day. If you are trading them on the last day, don’t leave your computer.

  • On 10/20, anony1 said:

    I bought 6 contracts of aapl 310 oct 2010 at $0.63 on friday before the market close and went for lunch thinking that they expire a week later. when I got back, the market closed with aapl at 315, putting my options in the money, but expiring the same day. I called my brokerage and they told me that they would buy the shares and I could sell them on monday morning.
    on monday morning the stock opened at 318, but the shares were not deposited into my account. When I called them, they said that I had too little funds in my account for them to deposit 600 aapl stock, so they decided not to put them in.
    I called OCC and they said that the options were not allowed to expire on friday. that means my brokerage did exercise and make profit on my options. Was there anything else the brokerage could have done to let me keep the profit? Shouldnt they at least return the premium I paid on the options if not the 5k$ in the money that the options were?

  • On 10/21, Pete Stolcers said:

    Is there anything they could have done, yes. They could have sold your call position for you before the close. However, they have thousands of accounts to monitor and what was out of the money 10 minutes before the close is now in the money at the bell. They can’t possibly monitor all of the potential problems and they rely on the customer to keep track of their positions.

    If they made money on the trade they could have credited you with the premium you paid for the calls. I think that would be fair.

    Is there anything they had to do, no. The options were going to be auto-exercised and you did not have the money in the account to pay for the stock. It is your responsibility to know what you are trading and when the options expire.  If they took your word for it that the funds would be deposited and the stock dropped $20, before you wired the money, you could change your mind and stick them with a huge loss. They are not going to take that risk. The brokerage firm’s rights are outlined in the Account Agreement and they protect themselves against such situations.

    I’m sure they sold the stock in after hours trading on Friday. They would not wait until Monday.

    If you are not happy with the way it has been resolved - leave. There are many good brokerage firms and you know that if a future problem surfaces, they do not have your best interest in mind.

  • On 10/21, anony1 said:

    thanks for your reply. I wish I had found your informative blog before this event! I did not mention one thing that happened on monday morning. Friday night, the brokerage firm told me that they would deposit the 600 shares on margin, and that I should sell the shares as soon as the market opens on monday. On monday before market opened, the stock was at 318 premarket, and the 600 shares were shown in my account. I was watching the market closely and waiting for it to open so I could place a sell trade on the 600. but just as market opened, the shares were removed from my account.

    Then I called them, and then they said we cant give them to you etc. Is what they did illegal? they are my options right, can they keep the profit from exercising and then selling the shares immediately?

    thanks again!

  • On 10/25, Pete Stolcers said:

    In the Account Agreements you will find that the brokerage firm protects itself. It was your responsibility to exit the position ahead of expiration. You did not act responsibly. Any action that was forced upon the brokerage firm as a result of your negligence will be outlined in the Account Agreements. If they make money, they will keep it. You did not have sufficient funds to cover the assignment. If they lost money on the trade, they would pursue collection for the debit.

    I’m shocked that they did not dump the AAPL shares Friday in after hours trading.

    That really does not matter. I think they could have at least scratched the trade for you - covered the commissions and the premium paid for the options. That would just be a gesture of good faith.

    I would talk to a Manager and ask for this resolution. You could threaten to file a complaint with the regualtors. Some firms might want to avoid that and it would be worth the $400 to get you out of their hair.

  • On 02/17, Ken said:

    Where is the option part of an option in an auto-exercise by the broker?

  • On 02/17, Pete Stolcers said:

    The option is only auto-exercised on the close Friday if it is in the money. This is to protect the customer (who forgets they have the position and does not close it) because the position has value. This is not a broker’s decision, it is mandated by the OCC (options clearing corp).

    If you don’t want the stock, sell the option before Friday expiration. That is your option.

  • On 03/24, Alirio de boer said:

    I had BIDU Mar 19 ‘11 $110 Call and Jll Mar 19’11 $95 in the money, but was NOT exercised after expiration. After asking and asking E*Trade came with this reply message:

    I reviewed your account and found that we just let your options BIDU Mar 19 ‘11 $110 Call and JLL Mar 19 ‘11 $95 Call expire in your account. You are correct that they were in the money before they expire but when you buy a call option that means that you have the right to buy the stock for the price of the strike price specified. If you will be exercised then you need to have the funds in the account to buy the stock but you do not have cash in your account to buy those stocks that is why we just let your call options expire.

    So, I did not have enough funds and the call option has expires in the money and E*Trade has not execute the contract and add the profit to my account. Because I did not have the liquidity to exercise the options for a profit E*Trade have exercised the options and keeps the profit and I have lose my Investment.

    Is this Option Expiration Rip-Off? What can I do

  • On 03/25, Pete Stolcers said:

    First of all, shame on you. You either needed to fund your account to cover the margin requirement for the stock or you needed to be responsible enough to get out of your position on or before exipriation.

    Secondly, stop blaming E-trade for your error, you screwed up. No matter what the situation, you needed to make provisions to get out of the calls. A simple conditional order could have been placed with a time constraint for the close Friday.

    Now for E-trade. ALL IN THE MONEY OPTIONS ARE AUTO-EXERCISED BY THE OCC (Options Clearing Corp) ON EXPIRATION. The firm probably sold the stock in the open market after hours and exercised the calls, pocketing the difference.

    They could have been up front with you and told you this. They also could have split the profits with you.

    They are protected by the User Agreements you signed when you opened the account. If you can’t afford the position, you have no right to the profits.

    If they would have exercised the calls and you came in long 1000 shares of BIDU Monday, the stock could have dropped $20. Then, you decide you don’t want the position and you walk away from the account, leaving them with a $20,000 debit. They are never going to put themselves in that situation.

    You can voice a complaint with the firm or FINRA. You can also vote with your feet and move to another brokerage firm.

    Whatever you do, learn from the situation and never let it happen again.

  • On 09/17, Vera Waitress said:

    I’m so embarrassed to post this that I used a pseudonym to hide my identity.

    If you’re foolish like me and let your options expire a few cents in the money this month and don’t have funds to pay for the exercise of stock, E*trade allows you to call AFTER the market closes (until a 4:15 EST cutoff) and make a “Do Not Auto-Exercise” request.  This saves you the embarrassment of going debit on your account if you have inssufficient funds to handle an exercise, but this doesn’t give you any recourse in liquidating the options to recoup any money.  (You eat the option price and let E*trade keep it, apparently.)

    That’s fine, but I didn’t call until 4:30 which is after the “do not auto-exercise” cutoff.  Ugh.  (Story of my life.) The rep then told me they put in a “manual” request, and couldn’t guaranty that my options wouldn’t be auto-exercised because I missed the cutoff.

    Then the E*trade rep told me in that case, that my 2 SEP 55 calls which were .07 in the money at expiration would be auto exercised, and my account would show a debit of $11,000 which I would have to pay!  This didn’t sound right to me-- E*trade isn’t going to go out on a limb for some two bit hack customer like me and buy $11,000 worth of stock, hoping that I put at least half that in margin in order to turn around and liquidate the stock monday morning.... are they? 

    Then, I asked the E*trade rep “Can I just turn around and sell the stock that I haven’t paid for yet and reverse the debit?” He hemmed and hawed and said “Uh, well, sure, but we can’t be responsible for the loss if the stock goes down.”

    I don’t think this guy knew what he was talking about.  Based on these messages, E*trade won’t even buy the stock.

    But my question is, if they let me off the hook and don’t auto-exercise the stock, what will the likely fees be?  Auto exercise fee?  A fee for the hassle?  A fee for my “get out of jail free” card?  I deserve to pay them all, I know.

  • On 09/20, Pete Stolcers said:

    You will be auto exercised and it is not a function of Etrade. The OCC (Options Clearing Corp.) looks at all of the open interest and if the options are in the money, they auto exercise to protect the customer. The OCC notifies Etrade that the calls were exercised and then the firm allocates the shares based on which accounts are long ITM calls.

    You will come in long shares Monday and if the stock moves lower, you will be responsible for the loss. If it moves higher, you will be entitled to the gains. You can sell the stock without meeting the margin reauirement and your account will be tagged with a Fed Call. It might be restricted for a while, but you get 3 Fed Calls if the firm chooses to extend them.

    In any case, it is your responsibility to get out of positions. Pay attention!

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