To The Moon

“What happens if I am long options, and they finish in-the-money?” … “Will I be assigned?” … and et cetera.  Hopefully, I can walk through some common expiration-afternoon questions here and shed some light on the process.

Automatic Exercise

First, the Options Clearing Corporation (OCC) automatically exercises options whose official close is one penny or more in-the-money.  Those holding long calls would buy 100 shares for each call they owned after the close on Friday afternoon.  Those with short calls might sell 100 shares for each call they were short as of the close.  The short does not control the exercise.

After-Hours Activity

what happens if the stock price moves after 4 p.m. Eastern Time on Friday?  As any of you who trade in the after-hours market know, stocks continue to trade after the bell.  Option strikes can move from out-of-the-money to in-the-money, or vice versa.

Trust me, the professionals in this market watch this very closely. They have approximately 1.5 hours after the close to make their decision on whether or not to exercise.  The most common examples of this behavior are with ETFs like the Spiders(NYSE:SPY) and the PowerShares QQQ Trust(NASDAQ:QQQQ).  These options even trade through 4:15 p.m. Eastern, but the options are settled based on the 4 p.m. close.  Because of this, you might be assigned on an option you are short when you don’t expect it.

Small moves in broad-based ETFs are risky, but probably controlled.  However, when there is an unexpected event right after the close on an expiration Friday, things can get really crazy.  Such as FDA ruling, occurs that moves a stock a huge percentage.  The stock might close at $51, but if a drug is approved, the stock could be trading at $73 after the close.

In this instance, one could expect to get short calls assigned even at the $55, $60, $65, and $70 strikes.  All of them might not be assigned, because if the person long the calls did not realize what happened, he may not call in to exercise them.  Again, this is very rare, but it has happened.  For those who tend to be sellers of options, please remember: YOU DO NOT CONTROL WHETHER OR NOT YOU GET ASSIGNED … EVER.   If something happens, you are at the whim of the people long the options.

How can you avoid some of these corner cases?  You could close your positions before 4 p.m. Eastern.  If you do this, there is no exercise or assignment risk.  However, if you are short, you might be paying commissions and a small fee to buy back the options you feel will be worthless in almost every situation.

I think you should assess these case by case.  Is there risk in being short calls in the SPY that are 10% out-of-the-money?  Or is there risk in being short puts in the AAPL that are 20% out-of-the-money? Yes, but for heavyweights and large caps, the odds of this happen in the 1.5 hours after the close are very remote.  It is probably a risk you can live with.

$Apple(AAPL)$ $Invesco QQQ Trust(QQQ)$ $SPDR S&P 500 ETF Trust(SPY)$