Option Tips - Options And Expiry

Most options are never exercised, even if they are in-the-money on expiration.

If a trader owns the BT Mar £1.50 calls and the stock is trading at £1.75 on or near the expiry date he could have course elect to take delivery of 1,000 shares at £1.50. But more than likely he'd take the easy route and just sell the option in the market collecting the cash instead.

It is important to understand there is no difference financially from taking a profit via selling an Option versus taking delivery on the stock.

But some traders for whatever reasons do want to take delivery, or deliver stock on or before the expiry day. In this case they would instruct their broker to exercise the options or they would be automatically exercised on expiry if the Option was in-the-money.

To exercise options your broker will make sure that you have the necessary funds in your account beforehand, and while the delivery process sounds complicated, it is actually simple. Let the broker and his experienced bank office handle all the necessary paperwork.

The Importance of Liquidity When Dealing Options

When trading any financial instrument, liquidity is critical.

You want to conduct your business in markets with good volume and tight bid/offer spreads. A lack of liquidity means that you'll struggle to get a fair price when you enter a trade and almost won't get one when you want to exit in a hurry.

It is a subtle point with trading but more often than not the cost of doing business is the most important part of any trading plan.

• But where do you find out about liquidity?
  
  
• Firstly check the average daily volume and the open interest on the options
  
  
• Open interest in a derivative market is simply the amount of open positions at present
  
  
• For example if you were long 10 call options on Vodafone and a colleague was short 25 calls, the open interest would be 35 contracts
  
  
• The quick route to finding out this information is through your broker or via the Euronext daily sheets

Two Examples Of Using Open Interest

• You fancy Whitbread will rise significantly over the next few months and therefore with the leverage on offer, options seem the idea trading vehicle
  
  
• But a quick check on the open interest in the options reveals that there are only 258 contracts outstanding. This means a total commitment on just 258,000 shares, clearly a minuscule amount when dealing with a company the size of Whitbread
  
  
• In our opinion it's not worthwhile dealing because the bid-offer spreads will be very wide
  
  
• So if you want leverage then use another tool like Contracts for Difference - See our CFD section
  
  
• Your next trading idea is GlaxoSmithKline, and this reveals an open interest of over 50,000 option contracts
  
  
• You can therefore be sure the bid-offers will be tight and trading liquidity will be good

What Option Strikes to Use?

An area in which many people struggle is which option strike to trade. If a share is at £1.00 and you're bullish, which call option should you trade the £1.10, £1.20, £1.30 etc? Unfortunately there is never one size fit's all type of answer.

So ask yourself some of these questions -

• Where do you think the share price is going and over what time period?
  
  
• What the volume and open interest is on the individual option strikes?
  
  
• What does the daily chart look like, is the market trending, is it in a range etc?
  
  
• How bullish or bearish are you? The more so the farther the strikes you should be looking at and vice versa
  
  
• Possibly ask your broker for ideas, you won’t have to follow them but it’s often a good idea to get another opinion