The expense on exercising the put will never be less then the cost to cary the put vs the cost of short stock unless the stock is hard to borrow.
I saw from another post that you have been a professional option trader for years, so maybe you are trying to make a point I am missing but this post is simply wrong. That's not my opinion it is simply a mathematical fact. I am quite surprised you don't know this. Go sell a deep in the money Put with no bid on the Call, there are many, many of them out there so you have plenty from which to pick. The market maker will exercise that Put the same day. Clearing firms charge a simple fee that is capped at not very much at all to exercise so the cost you keep referring to is not the relevant issue. We are assuming the Put has close to 100 delta so the market maker will have to buy stock 1 for 1 to hedge the Put you just sold to him. The cost of paying interest on carrying both the long Put and the long stock is simply not mathematically worth paying when the equivalent Call position has little if any value. The market maker would literally be throwing away money if he didn't exercise the Put. So then the logic follows that if you have a Put that is OTM or ATM and subsequently becomes ITM by a sufficient amount it becomes an early exercise candidate. You are actually completely backwards on your hard to borrow point. If a stock is very hard to borrow then it is very much to the market maker's advantage to be long stock and he will be unlikely to exercise the Put. If you are short a very hard to borrow stock your clearing firm can be forced to buy in your stock arbitrarily overnight and you wake up the next morning with deltas you don't want.
Sorry you're right on the hard to borrow I got it backwards my apologies. Been a while since I dealt with that issue. Thanks for correcting me.
I think this is a very interesting question and I am glad you pointed out the mistake I made. Our office suite is inside the FIMAT clearing office here in Philly, so before the bell I took a quick informal and unscientific poll of about a dozen market makers before then went down to the floor. Itâs been a number of years since I was down on the floor trading. Hands down not one of the dozen said they would even early exercise a deep put where the call was no bid at a nickel. For the most part they all concur with your math, or their firms do but theyâre not sellers of the call at zero basically. Both of the âlocalsâ of which there are very few who make their own decisions on early ex didnât give it a second thought and the rest of the guys who were essentially box monkeys for huge firms and donât make the early ex decision for the firm mentioned their firms virtually never early ex any puts. The only caveat any of them mentioned were the guys in the SOX index which is a cash settled American style option, so when you exercise deep puts your net delta the next day is longer for each put or shorter for each call you early ex. Again, thanks for the correction on hard to borrow, itâs a HUGE issue for the reasons you mentioned on having your short stock called in. This is an interesting dialog.
Xflat, This really isn't a debate it is just math, you may have posed the question in the wrong manner, or they have no idea what they are doing. Here is a simple example. SHLD trading 154.60, August 200 Puts trading about 45.40. If a marker maker is long those Puts he is paying interest on 200 dollars per share. If the long interest is cheap, say 6% then he has to pay 200*.06/365(days in a year)*36(days to expiration). That equals $1.18. If you are going to tell me that you and those market makers are going to pay $1.18 to carry that Put and stock when they could just yell to crowd 5 cent bid for the call and buy how many they want and then exercise the Put then please give me your phone number and we will trade. Anyone else here think that paying 1.18 for a 5 cent call makes sense?
I am not arguing with you and there is no doubt in my mind that the math supports your point. I said it was an unscientific informal pollâ¦. Other then the 2 locals the other guys ( who make up the overwhelming majority of mmâs these days) donât even have a say in position management or early ex decisions.
actually, just as an thought experiment, i am trying to think of a scenario where exercise might not happen: an officer of a public company buys protective puts during a lock-up period in which he is prohibited from selling stock. the stock tanks and now he has a boatload of synthetic calls. he cannot exercise the puts during the lock-up, so either he eats the carry or sells the puts. either way, he's probably going to jail, since you can't trade derivatives during lock-ups.
I actually use a strategy by where I sell DITM puts. As soon as the balance of the intrinsic value dries up, the puts are exercised and the stock is put to me every time and prior to expiration. Joe.