read what tao and volskewtrader wrote again, there is no risk in what vol proposes, DO NOT EXERCISE THE PUT!
Buying the shares locks in the intrinsic value of the put...selling the same strike call locks in the extrinsic value of the put. Or if there's plenty of time (DTE) left you could let the position ride and sell your shares out on a bounceback rally. If you sell the shares out at $3.00 (basically gamma scalping), then you'll be long your original put for a massive credit.
Why shouldn't he exercise? I don't understand. If he can't sell it, and doesn't exercise it, it will expire worthless, no?
Against $1.25 XYZ stock price the ITM $3.00 put is worth $1.75 (intrinsic value) + [extrinsic premium]. The same strike OTM $3.00 call is worth just the [extrinsic premium]. By exercising the put too early, he is selling the [extrinsic premium] for zero....only locking in the $1.75 (intrinsic value) difference. For example, if the $3.00 call is still worth .25 cents (extrinsic value), then the $3.00 put should be worth $1.75 + .25 cents = $2.00 ( put call parity). If he exercises the put too early, he forgos the .25 he could have made by just selling the same strike call. No need to exercise early. The ITM put will be auto-exercised at expiration against his long 100 XYZ shares. At expiration, the put is worth the amount it is ITM...it's only worthless if it expires OTM. That put still has optionality if there is time left to expiration. He's giving away money by exercising too early.
If he can't sell the illiquid put outright, buying 100 shares of XYZ is the right move. He could then just quote the ITM put and 100 shares together as a put buy write spread to liquidate the position...if he doesn't want to sell the call to put on the conversion. The big delta of the put probably contributes to its lack of liquidity, so if he ties the put to the shares in a quoted spread he'll get a much tighter market from the MM
Thank you, good suggestion. Often when my options became DITM, I had to "pay" to get out: Selling it for slightly less than intrinsic. What if I don't have the funds to purchase the underlying as a buy-write?
Then you'll just have to avoid DITM's in less liquid high priced equities....unless you're willing to bankroll expensive stock purchases. I'm guessing rich high flyers like TSLA, AMZN, and NFLX have pretty liquid DITMs.
Hard to go from OTM to DITM with liquid stocks or indices. Once in a blue moon, one illiquid could go to DITM instead of expired worthless.
It would take me 10 seconds to just decide to get rid of something like this and maybe lose 5 cents (or not), vs having 20 experts discussing what to do with it
BTW, again, you don't even need bids. Market making computers will buy anything where you're willing to lose a few cents, like the extrinsic value. Though you may not even lose anything if you simply try placing an order at whatever price you want. No one else will be able to guess how much you can get for an option, without you trying. So try it, get out, done.