Nicole Wachs warns Don't be an Ostrich this Week.

We've entered our time machine and arrived at May expiration week. You decided to buy an option or ten on XYZ, expiring next month, which would be June. Let's say you spent about $5000 bucks. Unfortunately you did not wear your TradeKing Elvis Shades while making this decision, and these options promptly lost value. Disgusted, you decide you cannot bring yourself to login and witness the bloodletting that is occurring in your TradeKing account. Technologically speaking, you bury your head in the sand until expiration has passed, pending the elimination of the position from your holdings page. (Sound familiar? We've all been there at some point in our trading careers.)

It is now The Monday following expiration. You now have enough reserve to get back on the trading horse and login to your account. The holdings page, which you thought would be empty, displays a stock position in XYZ. On top of that, it's a stock position that is losing money! How can this be? Is this a mistake? Have you logged in to someone else's account?

Unfortunately this is not a mistake. You are looking at your account. What happened?

As mentioned, these options lost a lot of value prior to expiration. Many people feel that when in this situation, the best thing to do is just let them expire without a second thought. Here's the catch. Just because something may only be worth a few cents, that does not mean it may not expire in-the-money. If this option expires in-the-money, and you do not advise TradeKing NOT to exercise, this option is subject to OCC automatic exercise rules. The OCC states that if an option is in-the-money by 0.01, it will be automatically exercised unless contrary instructions are provided to the brokerage firm.

So what happens if your option is automatically exercised? You will end up with a stock position. If you are long calls, you will have a long stock position. If you are long puts, you will have a short stock position. For more on each of these scenarios, please read the blogs Put your Mind at Ease by Doc Maher and Dirty Calls by yours truly.

Please note that any position that may result from an automatic exercise or assignment is ultimately the customers' responsibility. Thanks for reading - and let's be careful out there!

Regards,

Nicole Wachs

TradeKing Staff

For my past blogs, click here.

Options involve risk and are not suitable for all investors.

Please read Characteristics and Risks of Standardized Options.

Photo: Ostrich on Flickr by MYSM

Thanks for the question UPod. Even though you may not have enough cash on hand, it is still possible that the option would be automatically exercised.

Wow, that would be quite a nasty surprise.   If that were the case,  I assume you would have to repay TradeKing (or whoever else) within a certain amount of time or else the position would automatically be closed and the funds would be recovered by TradeKing.  Something similar or the same as a margin call without actually having a margin account?

Yes, exactly. The client would be on the hook for any losses incurred as a result of getting into or out of the stock position. Liquidation of margin call positions would be very similar.

Thanks very much for raising these questions. We don't like nasty surprises and assume most people don't either. I hope these comments will help people manage their accounts appropriately.

Thanks,

Nicole Wachs