Here's What Happens When "In The Money" Options Expire

VTS Community,

Whenever we have one of our UVXY Butterfly trades expiring within the Volatility Trend Strategy  (click here for a video overview of the strategy)  I always mention that we have to close the trade out before expiration in order to avoid assignment on any potentially "in the money" Options. 

* Now the exception would be that if the strikes are so far out of the money that there is no chance of them becoming in the money by the end of the day.  If that's the case, sometimes we just let the trade expire and save the small trade fees. 

Out of the money options that expire are just removed from your account without consequence.  It's the "in the money" Options that this article focuses on so let's unpack what that means and why this is so important for traders to understand.

In the money vs out of the money

In the Money (ITM) refers to the situation where the strike price of the Option has been surpassed by the current market price of the underlying security.

- In the Money Options have intrinsic value and present a possible profit opportunity for one side of the Options contract.

- In the Money Options will also have a forced action if left to expire and your broker will exercise on those.

Out of the Money (OTM) refers to the situation where the strike price of the Option has not been surpassed by the current market price of the underlying security

- Out of the Money Options have no intrinsic value and will expire worthless at expiration.

- Out of the Money Options have no forced action upon expiration and are just removed from the traders account without consequence.

Resulting positions when Long Options expire:

#1)  When a Long Call Option expires in the money, meaning the stock price was higher than the strike price of the Option contract, the Option holder will be assigned 100 long shares of the underlying at the strike price.

#2)  When a Long Call Option expires out of the money, meaning the stock price was lower than the strike price of the Option, it has no value and is simply removed from the traders account.

#3)  When a Long Put Option expires out of the money, meaning the stock price was higher than the strike price of the Option, it has no value and is simply removed from the traders account.

#4  When a Long Put Option expires in the money, meaning the stock price was lower than the strike price of the Option, the Option holder will be assigned 100 short shares of the underlying at the strike price.

Resulting positions when Short Options expire:

#1)  When a Short Call Option expires in the money, meaning the stock price was higher than the strike price of the Option, the Option holder will be assigned 100 short shares of the underlying at the strike price.

#2)  When a Short Call Option expires out of the money, meaning the stock price was lower than the strike price of the Option, it has no value and is simply removed from the traders account.

#3)  When a Short Put Option expires out of the money, meaning the stock price was higher than the strike price of the Option, it has no value and is simply removed from the traders account.

#4)  When a Short Put Option expires in the money, meaning the stock price was lower than the strike price of the Option, the Option holder will be assigned 100 long shares of the underlying at the strike price.

Pay attention to potential assignment of shares at expiration

As we can see, Long and Short Options that expire in the money will have a forced action by the broker if they are left to expire.  You will either be assigned long or short shares depending on your contract.

Reasons why we don't want assignment of shares:

1)  Options we trade are very often part of a larger spread involving multiple contracts.  It is not part of the trade thesis to be taking share assignment of individual legs within that trade.  Our Butterflies are all or nothing.  Our Iron Condors are all or nothing.  We don't want to take assignment on any portion within that larger spread.

2)  When you do take assignment, you're now taking on directional exposure.  But many of our Options positions are meant to be market neutral  (Butterflies & Iron Condors)  and we don't want direct market exposure.  If we did we would have just structured it that way from the start.

3)  Margin requirement on shares can be significantly higher than the options that expired.  If you do get assigned, you could wake up the next day to a margin call, or some issues where the broker may have to close out some of your other positions.

Most strategies avoid assignment, but a few utilize it

Some of you longer term VTS followers will remember a strategy we traded at VTS Options called "The Wheel of Fun" where possible Options assignment was part of the strategy.  We would regularly take assignment of those shares and then had a follow up action to profit from getting rid of them later. 

* Assignment is quite literally part of the strategy, so it's an entirely different situation than our Butterfly or Iron Condor trades.  It's one of the rare times when potential of assignment is not only allowed, but welcome.

Click here for a video explanation of "The Wheel of Fun" strategy

For our UVXY Butterflies, we do not want any assignment of shares

Both regular Butterfly Options and Broken Wing Butterflies have 3 option strikes within its construction.  In the picture above those are:

- 1x Long Put @ 110

- 2x Short Put @ 100

- 1x Long Put @ 90

If any of those 3 positions expire in the money, meaning the stock price at expiration has surpassed the strike price, there will be a forced action by the broker upon expiration.

1)  The Long 110 Put will result in 100 short shares being assigned

2)  The Short 100 Puts will result in 100 long shares being assigned

3)  The Long 90 Put will result in 100 short shares being assigned

 If we were assigned on any one of those legs, or all three of them, that's not part of the strategy and we will definitely want to avoid it.

* We open and close our Butterfly Options as a spread, and only as a spread.  At no time and under no conditions is it desirable to take assignment of any of those shares either long or short.  If we wanted that, we would certainly take an entirely different trade that is unrelated to the original Butterfly and target that specific exposure with its own risk management plan.

Now you see why when we have trades expiring that may be facing some "in the money" (ITM) situations, we close the trade beforehand