Hi my question is specifically for the BUY side for naked options.

I took an options course many years ago and was taught that upon OPEX, that in-the-money options which were held through op-ex would automatically be assigned by your broker. This supposedly therefore eliminated the need to to sell in the money options, or vetical spreads before opex.

But comments that I have read from Gen and others lately have made me wonder if this information is either out-of-date, or is just flat-out wrong, since I have read comments implying that in the money puts should be sold prior to OPEX, or you somehow get screwed.

I completely understand how an option writer would be screwed by holding through opex. But I don't understand what happens to a buyer who does this.

FWIW - My broker is TOS, and I am only talking about stock-market options, not futures options.

1st. para) I think that your question in para 4 is about long ITM options.
We usually reserve the word naked for short positions which are
unprotected by related stock or option positions.

2) Don't overlook the issue of pinning, where either of the vertical strike prices is very close to the closing stock price. Just because it's ITM (or OTM) at close friday doesn't mean it will also be so at open monday. Can be a very big deal and major margin issue if your spread position is large.

3) If you do not close your position prior to OPEX you are vulnerable to weekend action. May help you or hurt you, may be a margin and/or hard to borrow issue in the case of a short. If you do close your position prior to OPEX you may get hosed by the marketmaker so choose your poison.

4) Both long and short option positions have similar (mirrored) problems at OPEX.

Good trading!

An option writer is not necessarily screwed or necessarily anything for holding through expiry weekend. When companies do stock buybacks, very often they will do so via selling naked puts, with the full intention of being assigned, and, of course, collecting the premium. (In and of itself, that is not a good reason for YOU as an individual trader to do so, but it's also not a warning against doing so, per se) If you are good and ready to become a stock long (and THAT is pretty much exactly what it means to sell naked puts) there is nothing wrong w/holding naked puts over the weekend. And of course if you have covered calls and your short calls finish ITM, it is rare (IMO) that you'd want to buy back those calls. Naked short calls over expiry? Ehhh, that's pretty risky. For what?

Inescapable, though, is PIN risk. CBOE rules have changed in that options ITM by only one cent are forcibly assigned/exercised. Now, this leaves you open to whatever might happen in after hours trading Friday or over the weekend action.

When folks say "sell (or close) before expiration!" they are speaking from the standpoint of well over 95% of options traders who simply do not want whatever risk the position held over the weekend might hold, good, bad, or indifferent.

For a long time, I deliberately traded into holding vertical spreads where both legs were ITM over expiration. And sure enough, sometime on Sunday mid-morning, I'd look and see that I bought CAT (say) for $60 and sold it for $65. I do not recommend this strategy, by the way. The math seems attractive but you pay one serious pile of commissions auto-executing out of the spread, into stock, into cash.

All ITM options auto-exercise unless there are explicit instructions to the contrary. ITM (for all shares & exchanges I am aware of) is .01 through strike from the official settlement on the Friday preceding the expiration (which is technically on a Saturday). An exercise of a pin-strike must be explicit, but most brokers fold auto-exercise into their standard options-trading-agreement.

IMO, cash is the preferred method of settlement, but not an issue in equities.

What determines "official settlement"?

Who gets to paint the tape and have you experienced pinning issues with an official settlement price on the other side of the pin from bid/ask reported shortly after market close?

I have one good expiry story. Buddy of mine who likes to take occasional ultra long shot bets---buying options with 1-2-3 days left (and has a decent track record at winning same) bought 115 qty CNX [coal] 80-struck calls (this was when CNX was trading at about 78 last year during coal frenzy days) He paid 20-30 cents. In total, it wasn't an insignificant amount of money. He did this in a Scottrade account where he had about $30K in buying power.

Friday, the stock just isn't doing much of anything and he figures he's hosed. This was a holiday weekend, so Monday the market was closed in the US. So, he does what he can to sell them off, for a dime, .15, whatever he can get. But he can't sell them all. Friday close rolls around and has 87 of them left, over $1 OTM. Ooops.

Sunday, news leaks out that China is having a massive coal shortage and is frantically bidding up the price of coal! Over the weekend, coal stocks light up!

Tuesday, at the open, CNX is trading at 82.x and he is awakened by a very, very nervous Scottrade broker asking him what he is going to do with the $718,000 worth of CNX stock (8700 shs!) he has in his account with his $30K buying power. LMFAO. He made about $26K on that deal.

^^^^^^^^^^

The thing about pin risk is not so much what happens...it's that you have utterly no control over it, and you have seriously already acidified your stomach watching the thing tick by tick as the market closes Friday, when all good boys and girls have dutifully sold or closed their positions well before then. If you have the buying power, don't care if you end up long, short, or flat, aren't afraid at some level of a margin call, then fine. Most traders do not like being *forced* into action.

Nice story but I don't get it - if it closes at 78 how come his broker exercised OTM options?

Maybe the news came out saturday morning and he was able to find his broker ready willing and able to exercise (good luck finding a broker on saturday morning!)

The point of the story IMHO is not to analyze the minutiae of what happened or didn't happen. It's that you're utterly powerless to exert any manner of control over the situation.

Like any options play whatsoever: It matters not what happens on one or two plays. Go do your play 100 times or 50 times and get back to me if you still like the play or think that it's a smart play.

I used to think covered calls were pretty good. Then I did 70 or 80 CC plays and the results simply sucked. I used to think auto-executing vertical spreads were cool. I did a bunch of them, far too many, and the results spoke for themselves. They suck.

IMO covered calls must be operated through up down markets and up down vol before you can evaluate. Try a CC portfolio with a short hedge (/ES or SPY puts depending on vol) balancing frequently for delta neutral to iron out market moves. Capture as many divis as you can. Hey sharpshooters let me know how you get on because it's more work and stress than I'm willing to take on!

Auto-executing verticals (buying ITM spreads for less than the difference in strike prices) sounds like an interesting play. Why did they suck? Did you buy as spread or leg in? With option exercise commissions $15 (TOS I think) how was that a problem? Or did you end up with too many pin issues (own at $60, fail to sell at $65)? Capture any divis?

An excellent story of what is pin-risk.

It's actually NOT what I myself think of as pin risk, at least in the ordinary sense. (But it IS a good story, though!) Pin risk is when you have 80-struck calls and the stock finishes at 79.97 after trading up to 80.13 and you are sweating bullets all f**king day Friday watching it and can't sleep Friday night because you don't know what's gonna happen. Technically, pin risk in its simplest iteration is when the stock finishes exactly at 80 and you have no idea what will happen.

Oxford, sorry, I missed your question earlier re: auto-ex'ing verticals.

I legged in; rarely, if ever bought/established the spread in a single operation. Yes, the idea does seem intriguing, particularly since you can establish a V spread in something sort of volatile but not insane, let's say CAT or BHP which by initial reckoning will give you $5 upon forced exercise for what, $3.80? with a little trading savvy, maybe even 3.low. Big stocks, lots of options traded, that's not the issue. Apparently you end up with a (5-3.80)/5 = 1.2/5 = 24% gross profit which is damn juicy by any measure.

Now you ask why they sucked. First, you have to consider that perhaps 1/4 to 1/3rd of them let's call it a solid 1/4 will not cooperate with your efforts, in other words, the stock will not go the way you want once you've bot (or sold) the first element of the spread. Most typically, you will want to sell the option closer to ATM because ATMs exhibit vega more, eg; they contain more "air" which you'd like to sell. To simplify, let's say you wish to sell an ATM put and (later) buy the ITM put on a stock rise; when such a put will be cheaper. Or you could reverse the order, it doesn't matter. Many people have a preference to not be naked short options but that's a personal matter.

OK, suppose you get your spread established for a debit of 3.7. You will either ride the position to expiry or, buy back the short option, and maybe even get the oppty to sell it again.

It gets into the same kind of mental goofballism that covered calls do...do I buy it back? Let it ride? Gee, in 3 weeks I will make a "guaranteed (ha!) 1.3 but I can buy the short option back for an apparent 1.1 gain so shouldn't I do that? Maybe I can sell the short leg again in a few days? In "a few days" you won't be able to get the same amount for the sold put, unless the stock tanks further. Maybe you have to settle for selling it for a 1.1 net debit.

Establishing the spread does NOT guarantee anything, because that five dollars (or ten dollars---sometimes I used the strike $10 higher, which saves a few dimes) IS NOT YOURS until the WHOLE SPREAD FINALLY EXECUTES! And that is what is evil and what will scorch you. You tend to count the $5 or $10 as "yours" because you see the dual-exercise in three weeks...but lots can happen to make that money *not* be yours! I found that I felt compelled to watch and was tormented by the spread positions I put on just as much as I did as when I bot straight long options...which are massively easier to protect or just sell out of at either a MUCH bigger profit than the limited-gain structure of the auto-exercised options. (I would bet that TOS has a hedging calculator that would make this less nerve wracking)

But the buyback oppty comes precisely at a time when the long option LOSES value, and by definition, the ITM one loses value a lot faster than the short ATM one. Its delta is much higher, right? So when it (the stock) goes against you, the long side goes against you faster than the short option lots faster. Whenever you buy the short one back, your daily position will appear to have lost money, because that loss will show up in the (still remaining) long put. It will also feel like you are overpaying to buy back the short put. And, just like convoluted covered call plays, you can analyze the crap out of them, sell, buy back, resell, buy back, sell a lower strike, buy back, sell a higher strike (all against the same lot of shares) and in smallish lots, at the end of the whole exercise you've made a stupid $13 for watching the thing like a moron.

That's why they are ****ty plays. I took my own advice. I did the play 100 times (actually, probably 300 times) and when all the plays were done and all the storys told, I lost money overall.

They are HELL to unwind and if you don't pay taxes M2M they are ABSOLUTE HELL to account for.

I am not saying I did every one of the ones I did masterfully. That is an unrealistic outlook. I just found that many, many times, I became locked into positions where I would have been much happier not being involved.

If anyone wants to try this make sure you read what Gamma says above.

I'll add my 2 cents.

1) What I'm talking about here is volatility trading relying on reversion and taking advantage of temporary market imbalances. Which you are in a position to do as long as your account remains relatively small because the big boys can't be bothered.

2) Yes do it M2M or you'll spend several weeks on http://www.gainskeeper.com
or other fine software service to straighten out what you have done entry by entry.

3) Don't plan any vacations at OPEX. Or at any other time until you've figured out what you are doing.

4) My CC program worked nicely starting April 2008 but ran into a little difficulty later that summer. Which is why dynamic hedging needs to be part of the equation. You really need to understand the greeks and trust whatever program you are using.

5) Rather than trade around just make your bets (spreads, CCs, whatever, leg in if you like ) and hold till expiration - but deal with pin issues if otherwise they will blow up your margin. If you keep ducking in and out it'll drive you bonkers.

6) Be alert to dividends. Try to receive them, don't let some sharpie exercise on an ITM short call and stick you with a short divi. (You'll understand this quite clearly the first time it happens to you

7) Understand that what you are doing requires paying your dues for a long time. It's not something you can master quickly or inexpensively. Good luck!

Zactly, Ox. It is the type of play that is intellectually appealing; and in several ways it resembles selling covered calls. But it (the play, as a habit, as something you seek to do on a regular basis, multiple times) has the same kind of mental weirdnesses as selling CCs, has a nasty habit of locking you up in discomfort of your own creation. And, as I said (and I got this from Natenberg whose options book I found superb) go do your play 100 times and get back to me if you still like it as much as you did when you first heard about it and found it so intriguing.