Unexercised in the money?

Caveat: I just recently opened a personal trading account and am only playing long/short positions. My knowledge of options is limited.

Why are there so many unexercised in-the-money options? I'm looking at the options chain for F500 companies and seeing both puts and calls that are in the money. I realize that they're only 'in the money' for a few cents a piece, but why haven't they been exercised? Wouldn't firms with ultra-fast trade execution times and virtually non-existant trading fees simply exercise the in-the-money options and accumulate the small profits?

I must be missing something...

Thanks in advance for the help.

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Comments (10)

Aug 11, 2011 - 1:53pm

What you are missing is that the options themselves have a price/premium upfront that needs to be factor into the cost structure. To keep it simple, let's use an example with an exchange-traded option. Let's say there is a call option on Apple with a strike of $370 selling for $5 that expires in one month- Apple is trading for $365 on the day of the option purchase. One month from now let's say Apple stock as trading at $373. Is it profitable to exercise this option? Unfortunately no. You have to factor in the cost of the option. To exercise, you would need $370 to buy the stock from the option seller. But, here is the 'catch'- you already paid $5 for the option. So, if you exercised the option, the share of Apple you would pick up one month later would have effectively cost you $375, when the underlying Apple equity is trading for only $373. So, there is a threshold before 'in-the-money' options actually become truly 'in-the-money' - i.e. profitable. Your assumption about the high-frequency traders having low costs in the options market led you astray.

Bene qui latuit, bene vixit- Ovid
Aug 11, 2011 - 1:57pm
rls:
What you are missing is that the options themselves have a price/premium upfront that needs to be factor into the cost structure. To keep it simple, let's use an example with an exchange-traded option. Let's say there is a call option on Apple with a strike of $370 selling for $5 that expires in one month- Apple is trading for $365 on the day of the option purchase. One month from now let's say Apple stock as trading at $373. Is it profitable to exercise this option? Unfortunately no. You have to factor in the cost of the option. To exercise, you would need $370 to buy the stock from the option seller. But, here is the 'catch'- you already paid $5 for the option. So, if you exercised the option, the share of Apple you would pick up one month later would have effectively cost you $375, when the underlying Apple equity is trading for only $373. So, there is a threshold before 'in-the-money' options actually become truly 'in-the-money' - i.e. profitable. Your assumption about the high-frequency traders having low costs in the options market led you astray.

In this example, isn't the $5 already a sunk cost? You paid that already.
Now if you exercise it, ultimately your loss is 375-373 = $2. However, if you don't exercise and it expires worthless, you have lost the entire $5.

Is it because of commissions?

Aug 11, 2011 - 2:24pm
qweretyq:
rls:
What you are missing is that the options themselves have a price/premium upfront that needs to be factor into the cost structure. To keep it simple, let's use an example with an exchange-traded option. Let's say there is a call option on Apple with a strike of $370 selling for $5 that expires in one month- Apple is trading for $365 on the day of the option purchase. One month from now let's say Apple stock as trading at $373. Is it profitable to exercise this option? Unfortunately no. You have to factor in the cost of the option. To exercise, you would need $370 to buy the stock from the option seller. But, here is the 'catch'- you already paid $5 for the option. So, if you exercised the option, the share of Apple you would pick up one month later would have effectively cost you $375, when the underlying Apple equity is trading for only $373. So, there is a threshold before 'in-the-money' options actually become truly 'in-the-money' - i.e. profitable. Your assumption about the high-frequency traders having low costs in the options market led you astray.

In this example, isn't the $5 already a sunk cost? You paid that already.
Now if you exercise it, ultimately your loss is 375-373 = $2. However, if you don't exercise and it expires worthless, you have lost the entire $5.

Is it because of commissions?

True, it is better to lose $2 than $5, but consider you have to come up with the $370. But the fundamental question remains answered- the loss of capital in this trade is why high-frequency option traders don't exercise when they are only slightly in-the-money. Because, after all balances are settled, it is a losing trade.

You can't make up losses with volume.

Bene qui latuit, bene vixit- Ovid
Aug 11, 2011 - 2:02pm

Thanks for the response. What you explained makes sense. Looking at the actual AAPL options chain right now, wouldn't this be a profitable situation?

There is a call option for $185 and the underlying security is $178.70, totalling $363.70. AAPL is trading at approx. $373.97. Couldn't someone buy the call option, exercise it, and immediately sell the AAPL shares on the market making about $10 a share?

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Aug 11, 2011 - 2:17pm
al865149:
Thanks for the response. What you explained makes sense. Looking at the actual AAPL options chain right now, wouldn't this be a profitable situation?

There is a call option for $185 and the underlying security is $178.70, totalling $363.70. AAPL is trading at approx. $373.97. Couldn't someone buy the call option, exercise it, and immediately sell the AAPL shares on the market making about $10 a share?

I don't think you are looking at the ASK price.

Aug 11, 2011 - 2:25pm
al865149:
Thanks for the response. What you explained makes sense. Looking at the actual AAPL options chain right now, wouldn't this be a profitable situation?

There is a call option for $185 and the underlying security is $178.70, totalling $363.70. AAPL is trading at approx. $373.97. Couldn't someone buy the call option, exercise it, and immediately sell the AAPL shares on the market making about $10 a share?

Underlying security is AAPL, so why are there two prices? Unless im reading this wrong.

If you mean the 185 strike calls are trading for 178.7, then I dont know where you get your prices but im seeing the following pricing:
Aug 185: 189.75
Sep 185: 190.6
Oct 185: 191.25
Each of those have some time value altho miniscule

Aug 11, 2011 - 2:39pm

There's still time value on nearly every option.

Here's a simple explanation. Underlying is $75, strike is $70. Let's say the option is trading at $7, $5 for the intrinsic value and $2 for the time premium. Would you rather sell the option for $7 or exercise it for $5?

Additionally, not all options are American Call. Some are European Call, which means you can only exercise at expiry. This becomes important in high interest rate environments for puts and high dividend stocks for calls. But 99% of the time, early exercise isn't advantageous.

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