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Strategies & Market Trends : Classic TA Workplace -- Ignore unavailable to you. Want to Upgrade?

To: yard_man who wrote (46565)	7/21/2002 1:22:27 AM
From: UnBelievable	Read Replies (1) \| Respond to of 209892

The Put Is An Option To Sell Shares At The Strike Price For the holder who holds the option at expiration, on the Saturday after Option Expiration the option is exercised (automatically if it is in the money by more than .75). This means the Option Holder sells the shares to the writer of the option at the strike price. Unless the owner of the option actually owned the shares, the shares that are delivered have been sold short. As of Monday morning the owner of the option will have a short position in their account. If they have sufficient equity in their account they can choose to maintain the short position. If not, they must buy the shares to cover. As you say, they put the shares to the writer, however, this does not happen until Saturday and the effect is the creation of the short position in the option holder’s account unless the shares were in the account. If the option holder wishes to lock in the profit associated with the Friday closing price they could buy the underlying at market, but almost always they would just sell the option before the close of option trading. The writer of the option does not need to short the underlying, and most do not. While doing so does eliminate all of the risk, the spread alone, is not sufficient to offset the cost of capital associated with doing so. If this were not the case the transaction would provide a risk free opportunity to derive a return above the risk free cost of capital. In the case of options of long duration the premium may be in excess of the current risk free cost of capital, but this is because there is risk associated with interest rate changes which the writer of such an option is assuming in accepting a fixed premium and assumed interest rate fluctuation risk. Large institutional writers will usually engage in hedging transactions through the use of equity and interest rate futures, but these positions are the result of the use of risk models against the institutions aggregate equity and interest rate exposure. Individual writers are almost always engaging in the transaction as a speculative trade, based on their judgment that the underlying will go up. Writing a put is the same as buying a call; just as writing a call is the same as buying a put in terms of the speculation concerning the future direction of the underlying. Engaging in the transaction as you described it would be most similar to writing covered calls. While writing covered options is less risky than writing naked options, doing so is not a risk free profitable trade because of the cost of maintaining the position. Test it out. Assume that you could short on margin 100% of the price of the underlying. Calculate the interest cost of doing so for the option duration and see if you can find any put which can be sold for more than that cost. The same is true for calls. (if you find any be sure to let me know. <gg>. And hold an in the money put option through expiration and see what is in your account the following Monday.