>>>I have never exercised a put before.<<<
I have been out all day, and I see there has been some discussion. Let me restate things from my perspective. Some preliminaries:
1) When shorting one must first borrow stock - typically from a broker. Brokers don't always have them available to loan. Sometimes they can borrow them for you from other brokers. Sometimes they charge do to this.
2) Again, shorting implies a loan. Any loan arrangement/contract can be written with any terms/covenants. I believe it universally true that all share loan agreements allow the broker/lender to call the loan AT ANY TIME. If you broker calls your loaned shares away, you might be able to borrow more to maintain the position, or you might have a day or so to buy to cover.
3) Hypothecation (bonus material): When you open a MARGIN account (vice cash) you will sign an hypothecation agreement. You may not do it explicitly - i.e. it is in the fine print. The hypothecation agreement allows your broker to borrow your shares from you and lend them to anyone else he chooses at any time w/o your consent - before or after the loan. Of course you can sell your shares at any time, in which case your broker has to scramble to borrow shares from somewhere else to cover the loan of your shares to him. In margin accounts, hypothecation is not optional. If you want a margin account but don't want your shares loaned out, your broker will tell you to take your business to the next broker - who will tell you the same thing. That may sound like collusion, but it is the way business has been conducted for decades.
4) The owner of a put has the right (for a limited time) to force the put seller to buy shares from the put owner at a given price. If you own a put and exercise, shares will leave your account and cash will enter - regardless of your current position. If your are short 900 shares and exercise one put, you will end up short 1,000 shares. If you are long 1,100 shares and exercise one put, then you will be long only 1,000 shares when the dust settles.
5) The seller of a put can be "assigned" at any time during the duration of the option contract (before expiry). If a put you sold was assigned (exercised against you), then cash will leave your account and stock will enter. Your current position doesn't matter. If you were short 1,100 shares, and had one put assigned you would end up short 1,000 shares. If you were long 900 shares and had a put assigned, you would end up long 1,000 shares.
6) The seller of a put need never worry about becoming a "naked short." He gets the stock. He may not want it, but that was the deal when the contract was executed.
7) The owner of a put can end up in a "naked short" position. It all depends upon the availability of shares to borrow should the put owner exercise for more shares than are currently in his account.
8) The owner of a call need never worry about the availability of stock in the market. He will get his shares if he exercises.
9) The seller of a call has to worry about becoming a naked short if he has sold calls representing more stock than is currently in his account (has naked exposure). If the naked call is assigned stock will leave his account. If he can borrow to remain short, then fine. Otherwise he will have o buy to cover.
I hope that covers things in general and answers your first query. For your other query: If you wanted to remain short you would not have exercised. I stand by my position:
1) If you exercise a put, you simply morph from one form of shortness to another.
2) If you exercise, you may not be able to remain short if shares were not available to loan to you. If you were long the shares and the put, you basically bought the put for insurance, and upon exercise you would have the "covering" long shares. Being long stock and long a put is basically a neutral position,
3) If you own a put, you paid for time. If you exercise, the time value is instantly lost...forever. Hence if you fundamentally wanted to be short - were convinced that things would proceed smoothly downward, you would not waste the "time value" by exercising. Besides paying for time, you also paid the option spread when you bought. Those are sunk costs. You can sell the put at no additional "spread expenses." You still bear the option "ticket charge."
4) As a fine point regarding statement 3 immediately above, the decision to be synthetically short (owning a put) or directly short (borrow and sell shares) depends upon "delta." Delta is the rate of change of the put value relative to the share price. For options way out of the money, delta is small. For options deep in the money, delta is near "unity" (one). If you were extremely bearish short term, you would buy deep in the money puts or just get short the stock directly. The deep in the money puts would basically move point for point with the stock. |
