Can I Sell An Option Before It Hits a Strike Price? An options contract offers plenty of potential benefits to both buyers and sellers alike. For instance, they can be used to hedge risk, speculate on future market movements, and provide some income through the generation of premium payments.
Option buyers are not necessarily obligated to exercise their options if they don’t want to, while option sellers are. This flexibility can benefit each party depending on current and projected market conditions.
However, once an option has already been bought, you might wonder whether it’s possible to sell it again – especially if there’s a profit to be made.
Below, we’ll examine that question, and shed light on this most important of trading strategies.
What Is An Options Contract?
Stock options come in two forms: call options and put options.
A call option is a contract that gives the buyer the right, but not the obligation, to buy an underlying asset at a specified value – the strike price – within a certain amount of time.
Call options are often used as a way to speculate on future price movements of an underlying asset or to hedge against downside risk if a trader suspects the market will move higher.
On the other hand, a put option is a contract that gives the owner the right, but not the obligation, to sell an asset at a given price within a specified period of time. Again, put options are used to hedge against potential losses or profit from future share price movements.
Why Would You Want To Sell An Options Contract?
Naturally, if an option can be bought, a seller must be on the other side to make this happen. But why would anyone want to sell an option rather than buy it?
The main benefit of selling an options contract is that the writer gets to keep the premium that the buyer pays for the contract.
This is because when selling an option the trader takes on a certain degree of risk in doing so. If the market doesn’t move in favor of the buyer, then the seller gets to keep all of the premium.
How Do You Know What An Options Contract Is Worth?
Whether you sell a stock option depends on what kind of option you’re selling as well as how you view the current state of the market. Moreover, this entails deciding when to sell an option and how to price it.
However, pricing an option involves considering and evaluating several different factors. Ultimately, the value of an option is signified by its premium, which is informed by a variety of elements.
Intrinsic Value
An option’s intrinsic value rises the more that it’s in the money. This term relates to the difference between the strike price and the current stock price for a call or put, and implies to what degree the option presents a profit opportunity at any given time.
Moreover, if an option has intrinsic value, its premium will be higher than one that does not. An option that is moving out of the money is one that only contains an extrinsic value. For a call option, this means that the underlying security is less than the strike price, whereas for a put option it would mean one that is above the strike price.
Time Value
Another factor to take into account is the time value of an option. Time value refers to the fact that the value of an options contract changes the closer the expiration date draws in.
Indeed, when an option contract is first created, it has a certain amount of time value. As time progresses, the time value of the option contract decreases. The reason for this is that there is less time remaining until the expiration date of the option contract and thus less time for the underlying asset to move in price or to gain in intrinsic value.
Time Decay
Closely related to the idea of time value is the concept of time decay. Time decay describes the process by which an option’s value (specifically the time value) diminishes as the expiration date for that option approaches.
Because options give the holder the right to buy or sell an asset at a set price on or before a certain date, time decay works against the holder by eroding the value of that option as its expiration date gets closer. Time decay is often referred to by the more technical term, theta.
When Is The Best Time To Sell An Options Contract?
If you’re the owner of an options contract who intends to sell, you would need to balance the probability that your current position will end up being profitable versus the value of the premium that you would receive from selling the contract early.
For this to be beneficial, it would require that the option is in the money at the time of selling. In addition, you would also have to factor in the implied volatility of the premium, as well as the time value and time decay mentioned above.
More importantly, perhaps, the decision to sell an option might come down to whether you were using the instrument to hedge an investment – or whether you were using it as a method to speculate on a beneficial price movement.
For hedging purposes, the risk of selling an option early might not be adequate compensation for the risk involved, especially if you were to write an uncovered call.
Not All Options Are Created Equally
It’s important to note that the kind of options contract we’ve been discussing so far has been one known as an American-style option. This option allows traders to realize the profit on the option contract before the option’s expiration date.
However, there’s another kind of stock option known as a European option. The principal difference between an American option and a European option is that a European option can only be executed on its expiration date and not before. One consequence of this distinction is that an American option typically comes with a more expensive premium than its European-style counterpart.
In essence, the fundamental aspects underlying each kind of option are much the same. For example, both are derivatives, giving the holder the right to buy or sell an asset at a predetermined price. In fact, while a European option can only be exercised on the expiration date, it can still be sold back to the market before that time.
That said, for a European call option to be profitable on the expiry date, the underlying asset must be trading so far above the strike price that it covers the option’s initial premium. Similarly, for a put option to be profitable, the asset must be trading at a value sufficiently below the strike price to make up for the contract premium too.
Most of the options traded on the major exchanges are of the American variety, while stock market index options are normally sold as the European kind.
So, Can I Sell An Option Before It Hits a Strike Price?
While European options can be sold back to the market before their expiration date, only American options can be exercised and executed at their strike price before they expire.
However, both options function in similar ways. They can be used to hedge a preexisting portfolio position, or leverage a speculative bet if the market moves in your favor.
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