Characteristics and Risks question

Discussion in 'Options' started by RainmanRam, Mar 29, 2009.

  1. I'm new to options and reading the Characteristics and Risks of Standard Options. I can't seem to wrap my head around the risk listed under chapter X->Principal Risks of Options Positions->Risks of Options Writers->#9 (page 66) which states:

    Although the rules of the options markets establish exdercise cut-off times by which exercise instructions of expiring options must be received by brokerage firms from their customers, OCC must acept all exercises which it receives before expiration--even if those exercises are filed with the OCC in violation of an options market's rules. <u> Accordingly, there is a risk that an optionwriter will be assigned an exercise that is made based on news that is published after the established exercise cut-off time and that the writer may not have an effective remedy to compensate for the violation of the options market's rules.</u>

    Can someone explain to me or give me an example of what is being said here?

  2. 1) You are short an Apr 60 call.

    2) Stock closes at 59.25

    3) Option apparently expires worthless

    4) immediately after the market closes, positive news is released and the stock is trading at 67 in the after-hours market.

    5) According to the OCC, all Apr 60 calls expire worthless and none will be automatically exercised.

    6) But professionals - market makers, hedge funds, etc will hear the news and if any of those people own the Apr 60 calls, then have a bit of time to call their brokers and issue what is known as a DO EXERCISE instruction.

    They do that for Apr 60 calls and Apr 65 calls. They can exercise the calls and sell stock in the after hours to lock in a gain.

    7) Not everyone is up to date on news, so some (perhaps many) of those Apr 60 and 65 calls will be allowed to expire worthless. But, if you are short that option - the warning you quote alerts you to the fact that you may be assigned an exercise notice and it's never right to assume it expired worthless until you know that to be a fact.

    8) You learn the 'fact' when you see your statement on Monday before the market opens (or Sunday, online). Verify your options expired worthless and that you were not assigned on any options you believed were worthless.

    9) No rules are violated. That phrase refers to the 'automatic exercise rule.' Investors have the right to exercise any option - even out of the money options - as long as the instructions are submitted prior to the cutoff time.

    This may never happen, but it remains a possibility.