September
Option Expiration
By Lawrence McMillan, editor
The Option Strategist
A very unique situation almost arose at September expiration. What if the markets had been closed on expiration day? What would have happened to the options?
Stock Options
It turns out that stock options would expire, as usual. One can exercise an option that is not cash-based without the market being open. Thus, he can also be assigned. One's broker merely makes an entry in one's account to buy or sell stock at the striking price. The occasionally happens to an individual stock, but has never happened with the entire stock market. Of course, in a situation like that, one would have been forced to guess just how far up or down certain stocks might open, thereby deciding whether or not to exercise a particular put or a call.
Index Options
According
to the CBOE Rules, index options would be treated differently,
though. They are "forward-looking." Therefore an
index's cash settlement price would be based on the next available
trade of each stock. So, an "opening settlement"
option, such as $SPX, would use the next trading day's
opening prices whenever that trading day might be. $OEX would
use the next day's closing prices. This makes sense because,
if one had hedged cash-based options with the actual underlying
stocks, he should rightfully have a chance to remove the hedge
simultaneously at expiration. The only way that can be done with
a cash-based option is for the market to be open and trading.
On a routine expiration,
some stocks in very large indices such as the Russell 2000 ($RUT)
do not trade on expiration day. However, when only one
or two stocks are in this state, the index's cash settlement
price is based on the most recent sale of such stocks
and the normal opening price of the stocks that are trading.
This prevents holding up the settlement of the entire index,
pending the next sale of one or two very illiquid stocks. However,
when the "entire primary market" does not trade, the
delayed settlement procedure is used.
Finally, the OCC has
the power to override the exchange rules and establish different
procedures.
Extending Expiration
The
above data are facts. What follows was someone's pipe dream.
There were rumors even postulated on TV, in the press and on
some unsophisticated Web sites that option expiration would be
extended because the market had been closed for four days during
the week prior to expiration. To me, this was a preposterous
rumor. First of all, options are a contract. That contract
specifies the expiration date. There is really no way to change
it.
A
fairly large Web site, which caters to novice option traders,
was telling its customers that there was a chance that expiration
might be extended. They intimated that extending option expiration
would be a "fair" thing to do. This was garbage of
the first nature.
Don't you think option
sellers would sue the pants off the exchange if the exchange
suddenly decided to give option buyers a break and extend expiration?
Of course they would! And if expiration were extended, would
all option expirations be extended, not just the Septembers?
What happens the next time there's a snow delay or hurricane
that closes the exchange? Do we extend all the options then,
too? This is a Pandora's Box that no exchange would want to open.
By the way, you can
see from our portfolio that we were long a ton of options.
So I am not taking the counter-extension argument out of any
sort of self interest. In fact, an extension would have been
beneficial to our positions. Rather, I am pointing out the obvious
that a contract is a contract, and should not be broken.
What's most disconcerting
to me is that this subject even came up at all. I view it as
a continuing symptom of the unsophisticated, uneducated type
of trader who is still fooling around with risk that is too large
for him. Then, on top of that, he refuses to accept the consequences
of his actions and wants some bail-out. The excesses of the bull
market have apparently not yet been wrung out.
If it had been just
a few traders asking for a legitimate clarification of expiration
dates, it may have ended there, but the fact that the media jumped
on board or at least gave the impression that the door was open
for an option extension only fanned the flames. I'm surprised
that someone didn't sue for an extension (who knows, maybe
we'll find out later that someone did).
September In-the-money Options
Finally,
there is one more fact regarding September expiration. Of the
nearly 89 million option contracts that were still open on expiration
day, about 46 million or 5.17% expired in-the-money. This is
the lowest percentage of open interest that we've seen
expire in-the-money since we began keeping these statistics just
about two years ago. Over that time, the average expiration
has seen 64% of the open interest expire in-the-money, so you
can see just how far below the average this expiration
was. Of course, it had something to do with the fact that a very
small percentage of calls expired in-the-money, while a very
high percentage of puts did. Routinely, in stock options,
more calls are traded than puts.
Even so, this percentage
(52% of option expiring with value is far greater than
the false numbers that are often thrown about regarding how many
options expire worthless. Those falsehoods sometimes state that
as many as 80% or 90% of options expire worthless a fact that
has led many a novice option trader astray, leading him to sell
options because he feels that there is such a huge percentage
chance that they'll expire worthless. Only after reality sets
in (via losses), does he realize that the chances of an option
expiring worthless are nowhere near that high.
Editor's Note: Lawrence
McMillan is editor of The Option Strategist, P.O. Box 1323, Morristown,
NY 07962, 1 year, 24 issues, $250; 3 month trial, $29. Mail or
e-mail. In his newsletter, McMillan provides commentary and recommendations
on option trading. Along with Price Headley, Lawrence McMillan
will be conducting a 3-day intensive option seminar on January
19-21, 2002 in Boca Raton, FL. Cost is $1,895 for 3 days; $595
for 1 day. For more information on early signup discounts or
to register call 1-800-724-1817 or visit the Web site at www.optionstrategist.com.
