The Renewal of Options

Options can very often be extended. Suppose you own a Call contract at 54 on a stock which has risen before the expiration of the option to 65. You feel that if you had more time, the stock could go higher—to 75, 80, or more—in another 60 or 90 days. Through your stock-exchange house or your option-dealer, arrangements may be made for an extension of the contract. The cost of an extension, if it can be made, depends on many things: the option price, the price of the stock in the market, the length of time of the extension, and, of course, the willingness of the original maker of the contract to extend the option.

The Exercise of Options Before Expiration

Just because one holds a Call or a Put option for 90 days is no reason to wait until the last of the option time to act upon it. Many times a stock will rise considerably above the Call price or decline much below the Put price during the time of the option, but the holder of the option who does not take timely advantage of the situation may find that at the expiration most of the profit that had been in the contract has disappeared. For example, the holder of a Call contract at 50 having 20 days left out of a 90-day contract, finds the stock selling at 65, at which price he would have a nice profit if he would close out the contract. But he waits until the last day or near the last day, by which time the stock has declined to 54, wiping out most or all of the profit. A contract can be exercised at any time before the contract expires'.

The Effect of Options on the Stock Market

Consider, if you will, what effect the exercise of options or the trading against options has on prices on the exchange. The effect is to stabilize. The buyer of a Put option is not a seller of stock as is a trader who sells, short. On the contrary, he is a buyer of stock and usually in a falling market. Let us consider the case of a man who, expecting the market to decline, buys a Put not on 100 shares but on 3,000 shares of a stock at 50. If the market declines to 40, and the man who owns the Put option is satisfied with such a profit, he may be a buyer of stock on a scale-down—500 at 40, 500 at 39, 500 at 38, and so on-until he has bought the 3,000 shares of stock covered by his Put option. His purchases strengthened the market on that stock.

I remember how, many years ago, a very large investor sold Put options in thousands of shares of a particular stock. The market as a whole became quite weak, but not this stock. Most of the holders of the Put options wanted to buy stock against their Puts and this action supported and stabilized the stock.

Call options also have a stabilizing effect on the market. The holder of Calls which are profitable closes them out by Calling or buying the stock which is specified in the Call contract and selling that stock in the market to complete the trade. A man who owns Call options becomes a supplier of stocks in a rising market. He sells the shares that he Calls in order to make his profit. Whether a man sells against his Calls in a rising market or buys against his Put options in a declining market, his actions are against the trend and, therefore, stabilizing and not destructive.

Effect of Dividends, Rights, and Stock Dividends

On the day that a stock sells ex a cash dividend on the exchange, the prices in all outstanding Put and Call options on that stock will be reduced automatically by the amount of the dividend. For example, the holder of a Put option and a Call option, both at 50, will, on the day that the stock sells ex dividend $1.00 on the Exchange, automatically reduce both the Put and the Call option price to 49. While the holder of actual stock would be the recipient of such a dividend when it is payable, the holder of a Call option does not receive the dividend, but reduces the price of his Call option. Conversely, one who is short actual stock when it sells ex dividend would be charged for the dividend, while the holder of a Put contract reduces the price of his contract and pays the dividend only in the form of the reduced price when and if he exercises his contract.

In the case of rights issued on a stock, the prices in all outstanding options are reduced by an amount equal to the price at which the first sale of the rights is made on the day that the stock sells ex rights on the Exchange. Thus, if the first sale of the rights on the day the stock sells ex rights is 1V, then the price of outstanding Put and Call contracts would be reduced by 1% points. The stock at the opening on the day that the stock sells ex rights would probably open down l1/^ points so that there would be no advantage to either the buyer or the seller of the options.

Suppose that one owns a Put and a Call at 52 and the company has declared a 5 per cent dividend. From the day that the stock sells ex stock dividend the holder of the Call contract, if and when he exercises his Call, calls for 105 shares of stock for $5,200 (the dollar amount specified in the original contract) and the holder of the Put option, if he exercises his Put, will deliver 105 shares for $5,200 (the total dollar amount specified in the original contract).

As an example: the holder of a Call on 100 shares of American Motors at 20, with stock selling at 40 after it has sold ex a 5 per cent dividend, would Call for 105 shares of stock for $2,000. Conversely, the holder of a Put on American Motors at 20 if the stock were selling at 10 (after it had sold ex the 5 per cent stock dividend) would Put 105 shares of stock for the sum of $2,000. If the stock has sold ex a 50-cent cash dividend and then ex a 5 per cent stock dividend, the holder of the Call at 20 would reduce his Call price to 19^ and then Call for 105 shares for $1,950.

copyright 2005 optiontradingstrategies.org
www.meta-formula.com