In this clip from the Industry Focus podcast, Motley Fool Options analyst JP Bennett explains how investors should handle options that are close to expiration. Listen in to find out when it's appropriate to contact your broker, when it's appropriate to just let your broker do all the work it would do anyway, and how to tell the difference between the two.
A full transcript follows the video.
This video was recorded on March 24, 2017.
Dylan Lewis: "I'm near the expiration of the option. Do I think about it differently if it's in the money versus out of the money?" This is something we touched on a little bit in the first half of the show.
JP Bennett: Yeah. When you get close to expiration, depending on the strategy and what your plans are going for, you do have to think about it a little bit differently. When we set up strategies like I referred to earlier, we just let them mature and see what happens in the market. But then, when you get close to expiration, if it's out of the money or in the money and what you need to do will, again, depend on the strategy and what's likely to happen over that couple of days. So, let's say you wrote puts and they end up out of the money, and you get close to expiration. You don't have to do anything. They're going to end without any value, so your best bet there, or, your appropriate course of action to minimize transaction cost and things like that is to do nothing, because after expiration Friday, your broker is going to come in and wipe those obligations from your account, and you're free to write more puts in the following day. If they're in the money and you want to take shares, don't do anything, your broker will automatically put those shares into your account and take out the cash needed to buy those shares.
On the flip side, if you have covered calls, if they're out of the money, don't do anything, they're going to expire worthless. If you're in the money and you want to sell shares, don't do anything, your broker is going to do it for you automatically. The differences come into play when you don't want that outcome. Even though, with puts, let's say you want to buy the shares at that given strike price, there could be instances where you want to do what is referred to as rolling the contracts. So, you'll buy back the contracts that you sold in the past, and you'll sell new ones. Maybe you sold April contracts. You can buy those back as you get close to expiration, and write ones for July or something along those lines. Same thing with calls. Basically, the nuts and bolts of it -- and I did a lot of rambling there -- is that it depends. More often than not, when you're asking a basic question with options, that's the appropriate answer. It's a lot easier when you have specific strategies and things like that to go through what you need to think about and do.
Lewis: But if you're working with some of the simple options strategies, then more often than not, the broker is going to automatically handle things in the background for you.
Bennett: There are certain instances where you're doing something that, just because of technicalities, the broker won't recognize, so you have to either call them up or take action ahead of time. But as long as the option is $0.01 in the money, the broker is going to automatically exercise it for you. Unless, if you have call contracts and they're worth one penny, you can call them up and say, "Dude, don't do it for me, it's not worth it." Otherwise, they're just going to do it. Whether or not you want that to happen is an entirely different matter.