After a turbulent 2020 that saw markets tumbling, the New York Stock Exchange announced it’s temporarily closing the trading floor for a fully digital market, starting March 23. Legislators and regulators are debating what to do, and many analysts are worried about a market shut down. But what happens to options if the market shuts down?
It’s a difficult decision, as your options expiration date will remain unaffected by the market shutdown. This leaves you with the decision of whether to exercise the option. Here’s everything you need to know about holding options when the market shuts.
What Are Options?
Options are a subset of derivatives, which differ from traditional stocks. In fact, you can buy or sell options for stocks, but also bonds, real property, ETFs, or mutual funds. Investors use options contracts to speculate and hedge their investments, as they provide the right to trade an underlying asset at a pre-set price. The right is not an obligation, however, so you have the option to not execute the trade if you hold long options.
These powerful investments provide income security, as you can create options to survive a variety of scenarios. There are two categories of options to consider:
1. Call Option
A call option is a contract that gives the holder the right to buy an underlying asset at a predetermined price until a set expiry date.
These are great when the market is expected to go up, as you can continue buying at the lower price and selling for the difference, generating a recurring income.
Consider a new real estate development where you place a down payment (known as the option premium) to buy a $1 million property but want to wait until its finished. When the multi-year project is complete, prices could have gone up 200 percent to $3 million. But because paid your premium, you can exercise the option to buy at the original $1 million
2. Put Option
A put option is the opposite of a call. It gives the holder the right to sell an underlying asset at a predetermined price until a set expiry date.
Consider The Big Short and the pharmaceutical episode of Netflix’s Dirty Money docuseries. These investors bet on an underlying asset’s value going down by borrowing the shares in advance with a premium.
Puts are often used to insure against losses. As the market tumbles during the COVID-19 pandemic of 2020, many investors depend on put contracts to mitigate losses. Some even shifted money from investments to derivatives.
So, what happens when trading stops? Read on to find out.
Why Does Trading Get Halted?
When trading is temporarily suspended, it’s called a trading halt. It can happen to a single security, an index, an exchange, or even the entire market in an extreme case.
A halt typically occurs in anticipation of a major news announcement to keep markets stable. By the end of the first quarter of 2020, intermittent market halts occurred daily around the globe.
So far, none of the U.S. halts lasted longer than 24 hours, but with panic selling rampant around the globe, no investment is safe.
The 2020 stock market crash began March 9, 2020 with a series of record-low drops in the Dow Jones Industrial Average (DJIA). The market lost over 20 percent from the February highs Each was the largest single-day stock market crash since Black Monday on October 19, 1987 at 22.6 percent, and the combined effect is not unlike the Great Depression.
In fact, the Black Monday that preceded the Great Depression was on October 28, 1929. On that day, the Dow lost 12.8 percent as the start of a four-day crash. Investors under 40 are unlikely to remember the 1987 crash and weren’t around for the Depression, so panic set in as Gen X and younger experiences signals of the worst market they’ve seen. The most significant market halts occurred on 9/11.
However, prior to the 2020 stock market crash, the Dow hit a record peak value on February 12. Markets are only temporarily being halted, and you have options.
How Are Options Handled When the Market Stops?
When trading is halted, the related options are frozen. You still retain the right to exercise them though. This is because it’s a binding contract with all rights and obligations implicitly laid out in the terms. Should the exchange nullify, restrict, or alter these terms, it would constitute a breach of contract.
This includes extending the expiration date until the date trading starts again. Of course, exercising the option is voluntary and a decision that each investor needs to make for themselves based on the information available for your investment portfolio.
Essentially, you’ll hold your position through the closure, and with a put, you’re hoping the market will open much lower than it closed. If your investment is on the S&P 500, for example, you won’t have an issue, as everything is cash settled by end of trading. However, if you’re in an outstanding long position, it could carry over into the next day, leaving you in debt.
If you choose to exercise your options, you’ll need to do so outside of the exchanges. Just because the New York Stock Exchange halts trading doesn’t mean you can’t still buy/sell/trade stocks using over the counter (OTA) and bulletin board markets. Even if a stock is delisted, there’s still a theoretic market. You can trade after hours, and you’ll have until the expiration date of your option to exercise it.
There is also an Options Industry Council that can assist you with more specific questions. You can reach them at their official website or by calling 1-800-OPTIONS to learn more.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.