In-the-money (ITM) calls and puts can sometimes trade for less than their 澳洲幸运5官方开奖结果体彩网:intrinsic amount (i.e. the difference between the stock and strike price), with the occurrence more common for deep-in-the-money options as you approach expiration day. On expiration day, there is very little time premium left in deep-in-the-money options🦄 and nearly their entire value is intrinsic value. While options pricing theory may insist that an option should never trade for less than its intrinsic value (without accounting for commissions), real l🅷ife trading is rarely that simple.

Many investors accept this as normal and close out positions below intrinsic value but there is a better way to determine what you should get for a deep-in-the-money option. Theoretically, an option should not trade for less than intrinsic value because it would let 澳洲幸运5官方开奖结果体彩网:arbitrageurs simultaneously trade the option and 𓆏underlying stock for a guaranteed profit, with thos🌳e transactions continuing until intrinsic value is restored. With this in mind, let's see how you might get a better price for your option and increase profits.

Closing Long Call Positions

Let's say that on the December 澳洲幸运5官方开奖结果体彩网:expiration day, the stock of XYZ Corp is currently trading at $70.70 and you own 20 of December $65 calls that you would like to close (sell). The December $65 calls should be trading at or very near to the 澳洲幸运5官方开奖结果体彩网:parity price of $70.70 - $65 = $5.70. However, you see th🐼at it is being quoted at $5.20 if you sell the calls. The proceeds would be:

$5.20 x 20 x 100 = $10,400

Naturally, you can try to place a 澳洲幸运5官方开奖结果体彩网:limit order to sell at $5.70 (or more reasonably, $5.60—leaving a dime for the bid/ask spread). But let's say you try that and cannot get the order executed at that price. How else can you close an in-the-money option that is trading below parity? Like an arbitrageur, place an order to sell the stock instead of selling the call. Then, when the sell order is executed, immediately exercise the 澳洲幸运5官方开奖结果体彩网:call option. 

In the example, the stock is currently trading at $70.70. In this case, you would place an order to sell 2,000 shares at $70.70. Once the 澳洲幸运5官方开奖结果体彩网:sell order is executed, you simply submit exercise instructions to the broker. The terms of the option contract mean you will buy 2,000 shares at the 澳洲幸运5官方开奖结果体彩网:strike price of $65. So you receive $70.70 a share on the stock sale and then buy it for $65 on the exercise. The proceed⛦s will be:

(2,000 x $70.70) - (2,000 x $65) = $141,400 - $130,000 = $11,400

That's an additional $1,000 in your pocket.

You꧋r brok💧er may charge a little more to do it this way, but if the option is substantially below parity, it should be worth it. 

Brokers may suggest you short the stock instead of placing a regular sell order. However, if you short the stock, you are subject to 澳洲幸运5官方开奖结果体彩网:Regulation T and you may not earn interest on that amount over the 澳洲幸运5官方开奖结果体彩网:settlement period.

Delivering Non-Owned Shares

You may hear objections about selling shares that are not in your account but regulations allow it, even if your broker may not. Most shares are held by brokers 澳洲幸运5官方开奖结果体彩网:in street name and it is perfectly acceptable to put in a sell order without the shares, as long as they are delivered within the settlement period. If the broker requires that shares be held before selling them, advise you will immediately submit exercise instructions to purchase the shares. There is no reason this shouldn't be allowed because the 澳洲幸运5官方开奖结果体彩网:Options Clearing Corporation guarantees delivery of the shares at settlement.

Once you sell the stock, it is very important to submit exercise instructions on the same day. Otherwise, th🐽e sale of stock and purchase from the option exercise will not settleꦉ at the same time. 

Closing Long Put Positions

What if you are long deep-in-the-money 澳洲幸运5官方开奖结果体彩网:put options? In the ওsame example, let's ꦫsay you are long December $80 puts and they are being quoted at $9.00. Selling 20 of those puts to close out your position would net proceeds of $18,000.

However, because the stock is trading at $70.70, those put options have an intrinsic value of $80 - $70.70 = $9.30, a difference of 30 cents. In the case of put options trading below intrinsic value, you simply need to buy the stock and then exercise the puts.

You would pay $70.70 to buy the stock and receive ꦿ$80 from the put exercise. You would then receive the full intrinsic value of $9.30, or ♎$18,600, a difference of $600. Again, the extra commissions will be well worth the additional effort.

Market Makers

Why do options sometimes trade below intrinsic value? It's usually because algos or 澳洲幸运5官方开奖结果体彩网:market makers are having difficulty laying off risk. Basically, it comes down to the 澳洲幸运5官方开奖结果体彩网:law of supply and demandও. If there are more sellers than buyers on expiration day, it may generate an imbalance that allows&🌳nbsp;the algo or market maker to charge a high premium for completing the transaction.

The algos or market makers are buying the call and selling the stock. However, there may not be enough volume or interest to br💮ing prices into equilibrium. If they buy the option and the stock continues to fall, it could generate a loss by the time they short the stock. As a result, they charge a premium to coverඣ the risk while awaiting execution.

Arbitrageurs and 澳洲幸运5官方开奖结果体彩网:retail investors can join in and buy the call and sell the stock, but if they do not have an existing position, they have to purchase the option at the 澳洲幸运5官方开奖结果体彩网:ask price and sell the stock at the bid. With wide spreads common in deep ♋in-the-money options, this leaves little or no room for🐻 error.

Competing With Market Makers

You may be tempted to compete with algos and market makers, mimicking their strategies. While it seems like low hanging fruit𒁏 waiting to be picked, this is not a reco𝕴mmended strategy.

Let us assume the December $65 call option was being quoted as $5.20 bid and $5.90 asked. So what if you simply put in an order (for 10 or more contracts) at a slightly higher 澳洲幸运5官方开奖结果体彩网:bid price of&ඣnbsp;$5.30? Now you have the best price and the quote will move to $5.30 on the bid and $5.90 on the ask. If you get hit at $5.30, you can sell the stock and make a quick profit.

But there is a catch. If you bid at $5.30, algos and market makers will bid $5.40 and you are giving them a call option for 10 cents! This happens because they can make money by buying a deep in-the-money call below 澳洲幸运5官方开奖结果体彩网:fair value. If the stock falls while your bid is open, the market maker will sell it to you at $5.30. For very little risk, their worst outcome would be losing 10 cents. In other words, they use your buy order as their guaranteed 澳洲幸运5官方开奖结果体彩网:stop order. So, if they buy the option for $5.40 and it doesn't work out, they ಌknow they have a buyer at $5.30 - you!

There used to be an order called "exercise and cover" to use in these circumstances. It meant the broker would sell the stock, covering the sale by exercising the call (or buy the stock and covering by exercising the put). With澳洲幸运5官方开奖结果体彩网: increased liquidity in the options markets, this order is no longer used, but that doesn't mean you can't do it yourself in two transactions and at considerably less cost🐲 in commissions.

The Bottom Line

To get the best return, understand how options work and the markets in which they trade. This includes understanding that, if the market is offering you a price below fair value, you don't have to accept it.