Good question, right? I came across a great TK Community forum thread on this topic this week and thought I’d share this info with my blog readers, too.

10%? 35%? 70%? 90%

Those are just a few of the numbers you might hear bandied about, but the correct answer is this: according to the Options Clearing Corporation’s 2006 trading year results (and as reported in the TK Options Playbook), around 17% of all options contracts opened got exercised. About 35% expired worthless, and almost half (48%) of the rest got bought or sold to close in the open market.

If these numbers seem surprising go back to the basics of option for an answer. It’s easy to lose sight of the fact that an option is a contract. We often think of options as hot potatoes that get passed around until they wind up in someone’s hands at expiration. But actually, if an option contract gets closed in the marketplace, it just ceases to exist and will therefore never make it to expiration. That’s why, when you enter an options order, you specify whether you are buying or selling “to open” or “to close” a contract.

Open interest

Someone needs to look at the big picture and keep track of the volume of options that are opened or closed in the marketplace. That's where the Options Clearing Corporation (OCC) comes in. Every day, the OCC looks at the volume of options traded on any given stock, and they make note of how many options were marked "to open" vs. "to close." And once they've tallied up the numbers, they can determine something called "open interest."

Open interest is simply the number of call and put contracts that exist at a specific strike price on a specific stock with a specific expiration.

Obviously, if more of the volume on any given option is marked "to open" than "to close," open interest increases. Conversely, if more trades are marked "to close" than "to open," then open interest decreases. (Remember: closing an option contract means it ceases to exist, and obligations on both the buy and sell side of the trade are relieved entirely.)

This brings up a point worth noting: although you can keep track of trading volume on any given option live throughout the day, open interest is a lagging number. It isn't officially posted by the OCC until the following morning, after they've diligently calculated their figures.

The myth about auto exercise limits

The auto exercise limit is the amount on option contact needs to be in-the-money (ITM) before an option will be automatically exercised on the investor's behalf by the Options Clearing Corporation, or OCC. Why do we have it? Because sometimes option traders fall asleep on option expiration Friday and don't make a decision as to what they would like to do with their ITM options. There's no reason other then that. This concept is basically a moot point now that the OCC changed the rule to auto-exercise from 5 cents ITM to now one cent ITM.  Thanks goodness! So now I will not have to explain this concept anymore.

Now you might be asking yourself: will the change auto-exercise limit affect what percentage of options get exercised every month? People would always misinterpret this, thinking "well, it's not 5 cents ITM, so I won't be assigned" - wrong. Most of the people on the other side put in a exercise notice, despite the OCC rule.

Mostly professionals would be exercising and professionals will exercise for a penny anyways. So the OCC just made it easier on everyone and said: we will exercise anything (no matter if professional or retail trader) ITM upon expiration, for anyone, unless we hear otherwise. Bottom line is about 99% of the options were exercised even for a penny anyways. So I suspect the rule change will not affect the end number much.

But I’ve always heard 70-80% of options expire worthless!

The most erroneous, and yet over-quoted, notion about options expiration is that 70-80% of options expire worthless. If you ever hear that in a seminar – and, if you attend more than one, I guarantee you WILL hear it – get up and leave. Think about it in common-sense terms: of all the options that “make it” to expiration, not all of them are calls. You’re usually dealing with a mix of puts and calls. If a put expires ITM, then the corresponding call is OTM, and vice versa. As they say, there are two sides and two opinions to every trade. To state that 80% of options expire worthless makes no sense in light of these facts – that would suggest that many people don’t like to exercise their ITM options.

Let me know if you have any comments or questions on this issue…it’s a tricky subject, but makes sense if you unpack it a little.

Regards,
Brian (OG)

[image: Hantlar / Dumbbell / Dumbbells by whyld  on flickr]

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While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.

Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. 

Interesting statistic, but I guess that makes sense as most options traders are speculators that are looking to profit from the gain in the options price and will sell to close their position instead of having to go through the exercise process.  This is especially true as there will almost always be some time premium left in an option before expiration so there would be almost no reason to exercise an option early.  Most of these 17% options exercises are probably related to people holding covered calls  that are fine with having their stock called away or that purchased puts and want to unload their stock that has moved down that now no longer would have downside protection as the puts expire.  I suppose there are also people that sell naked puts with the thought that they will buy the underlying stock if it declines to their out of the money strike because the stock would represent a good value there.

 I had an additional question about some of your past posts regarding the ability to roll positions.  I am specifically referring to the possibility of rolling an options spread out to the next month.  This is sometimes necessary when the underlying price is approaching the short leg of a credit spread that one is holding or if the underlying has moved the spread partially in the money.   For example, if I hold an SPY August 130-131 call credit spread and wish to roll out and up to the next month of say the SPY September 135-136 call spread, is there a way to process this all in 1 order transaction.  I am able to do this using some of the other options brokers I use, but haven't figured out a way to do this on the Tradeking platform yet.  Part of the reason for this is that when you roll the spread with most brokers you are able to maintain the original level of maintenance, so you can open the same number of September spreads as you had in August, even if the August spreads were partly in the money and on paper would be showing a loss.  This way you are able to often repair a trade without having to use extra maintenance margin.  Thanks!

Brian,  are there any indexes more prone to exercise than others?  I have heard that OEX and SPX you are more likely to be exercised. I also thought if you were selling an option with a Dividend that you have to be more careful as you could have early assignment at the time of dividend payment.

Also can you talk about how TradeKing would work with a client on same day substution if you ran into trouble.

Hello Pauly B,

When it comes to indexes, not ETFs but indexes, most of them (98% I would guess) are European style expiration. This means they can not be exercised early; they can only be exercised at expiration. This is the case with the SPX index options. It is funny the other one you mentioned is one of the few exceptions, the OEX. The OEX was the first index to have options trade on it. It started as the CBOE 100. Because it was the first index with options they decided to make the expiration style like stock options - American style. This means it can be exercise early and yes there is a risk of that happening. They have actually introduced a European style version or the OEX that trades under the symbol XEO. There are a lot of nuances on early exercise in general and on index options. So here are some blog posts that will explain the concepts in detail.
early exercise: part 3 10/15/07 03:00 AM
early exercise: part 2 10/08/07 03:00 AM
early exercise: part 1 10/01/07 03:00 AM
Index options explained: part 4 04/16/07 03:00 AM
Index options explained: part 3 04/09/07 03:00 AM
Index options explained: part 2 04/09/07 03:00 AM
Index options explained: part 1 03/26/07 03:00 AM
Regards,
Brian (Og)

OG,

What if you bought a call or a covered call and the call option is ITM, however, you are not called out in the covered call or you did not close the call before the expiration date.  What happens to the profit you earn?  Do you lose that money or is option(s) closed for you and the money is placed in your account?

If you had a covered call position on, for example you bought 100 shares of stock at 48 and you sold one 50 strike call against it. You went to expiration and never bought to close the option you sold. Now the stock is at 52 and we are at the close on expiration Friday. If this is the case the Options Clearing Corporation would exercise the call on behalf of the owner and you would be assigned and have to sell your 100 shares to him at the strike price (50). The cash for the sale of the 100 shares at 50 would then be placed in your account.

Hope this helps..

Brian (Og)