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Do You Understand Option Expiration, Exercising, and Assignment? Now You Will.

January 31, 2013 by Don DeBartolo| Tips & Strategies

It is essential to understand option expiration, exercising, and assignment as a commodity option trader. Know these principles, whether purchasing outright calls or puts, selling or “writing” option contracts, or using complex option spread strategies. Not only will you be better equipped for such events, but also having this acumen could potentially improve your trading performance.

Commodity option contracts are derivatives, deriving their price from another asset class. An option contract derives its price from the underlying futures contract. Like futures contracts, option contracts have expiration dates set by the exchanges. The expiration date of a futures contract is the last trading day before physical delivery or cash settlement. The expiration date of an option contract is the last trading day or last day to exercise an option. Exchange rules differ per contract about the time an option contract will cease trading on expiration day. It may either be the underlying futures contract open outcry pit close or electronic exchange close. Option contracts will expire before the expiration date of the underlying futures contracts for purposes of exercising and assignment. There is correlation between time value (premium in relation to days until expiration) and intrinsic value (premium in relation to the strike price’s distance from underlying futures contract price) to the contract expiration date. As an option contract draws near its expiration date, both time value and intrinsic value are decreasing. Unless it is an in-the-money strike price, that intrinsic value is a one-to-one ratio of the strike price in relation to the underlying futures contract. For example, a long March 2013 Crude Oil 98.00 call will be valued at 1.00 points (or $1,000) if futures are at 99.00 on option expiration (February 14, 2013). On the other hand, if futures are at 97.99 or below on expiration the option contract is valued at zero.

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Exercising of a long option contract can take place any time during trading hours before the option contract expires. Long (purchased) commodity option contracts (calls or puts) have the right to exercise the option. Commodity option trading follows American Style rules as opposed to European Style rules, in which options may only be exercised on the expiration date itself. Simply notify your broker of your intention, after confirmation, the option contract(s) is transferred into a futures position(s). A long call option will become a long futures position from the strike price. A long put option will become a short futures position from the strike price. The initial margin requirement for the underlying futures contract must be available in the trading account. Keep in mind the premium paid is forfeited, as well as any potential gains there may have been in the options market. After the close on the last trading day, all in-the-money options will be automatically exercised, unless notice to cancel automatic exercise is given to the clearinghouse. There should be notification of option exercising before the open outcry session commences trading the following day of the underlying futures contract.

Assignment of a short option contract can also take place anytime during trading hours before the option contract expires. The “writer” (seller) of a commodity option contract (call or put) is obligated to the underlying futures contract. The clearinghouse will assign contracts randomly. Remember, commodity option trading is a zero sum game, for each buyer there must be a seller. A short call option will be assigned a short futures position at the strike price. A short put option will be assigned a long futures position at the strike price. Note assignment of a futures contract is possible even if your short option is out-of-the-money. There should be notification of the assignment before the open outcry session commences trading the following day of the underlying futures contract. The initial margin requirement for the underlying futures contract must be available to hold the position in the trading account. Otherwise, the futures position must be liquidated or funds added to the trading account to cover the initial margin deficit. An assigned short option contract collects the full premium. Therefore, the break-even price becomes the premium minus the intrinsic value. For example, a short March 2013 Crude Oil 98.00 call option, sold for 50 points, will be at break-even (not including commission and fees) if futures are at 98.50 on option expiration (February 14,2013).

To continue your commodity option trading education I invite to view my video on Contract Logistics.

Happy Trading!

Daniels Trading Market Spotlight

Filed Under: Tips & Strategies

About Don DeBartolo

Don C. DeBartolo is a Series 3 licensed broker registered with the National Futures Association (NFA). As a former arbitrage clerk in the S&P 500 futures pit at the Chicago Mercantile Exchange (CME), Don has floor trading experience. Taking his trade execution expertise and ability to navigate a fast-paced environment, Don transitioned to the brokerage side of the business. Since 2005, he has worked at Daniels Trading, a brokerage firm in the heart of the financial district in Chicago. His responsibilities as a broker include providing market analysis, trade execution, and money management to his clients around the world. In March 2010, he developed a formal trade advisory for clients of the firm seeking specific trade recommendations and subsequent risk management.

Due to his widespread proficiency and experience with the futures and commodity options markets, he is able to offer his clients timely insight, specialized trade recommendations, and educational information through various videos and writings.

Studying at Loyola University Chicago, Don discovered the international sport of rugby. Still today, he plays for the Chicago Griffins, a member of the highest league of rugby competition in the United States. Skill and discipline are two traits that carry over from the pitch to the trading screens.

Risk Disclosure

WHEN INVESTING IN THE PURCHASING OF OPTIONS, YOU MAY LOSE ALL OF THE MONEY YOU INVESTED.

WHEN SELLING OPTIONS, YOU MAY LOSE MORE THAN THE FUNDS YOU INVESTED.

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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