exercise deep in-the-money calls?

newbee2000

Out of curiosity I recently started to trade call options.

I have read a lot about it but when I actually started to buy some using e-banking there where some things I didn't completly understand.

1. If an american-style call option ist deep in-the-money e.g. spot-price == 20$, strike price == 10$ (ignoring interest and fees in this example) why should I not just excercise the call?

An Example from UBS e-banking:
Facts
ISIN:
CH0035774741
NSIN:
CH: 3577474
Common: 041582189
DE: UB0DYH
US: H892CY237
Industry (Telekurs):
Banks/Credit institutions
SP investment profile:
Leverage
Underlying asset class:
Equity
Product group:
Warrants
Product type:
Warrants
Issuer:
UBS AG
CFI code:
RWSTCB
Nominal:
CHF
Last trading date:
17.12.2010
Floor:
0.00
Callable by issuer:
No
Callable by client:
No
Expiry:
17.12.2010
Strike:
10 CHF
Type:
Call
Style:
american
Ratio:
20 / 1
Issue date:
26.02.2009
Issue price:
0.18 CHF
Pricing date:
26.02.2009
Repayment date:
22.12.2010


Key figures
Calculation base price:
0.37
Remaining life:
0.34
Remaining days:
123
Hist. volatility 180:
91.11 %
Avg. vol. last month:
19'278 (06.08.2010)
Break even:
17.6
Premium:
-0.057
Premium p.a.:
4.98 %
Gearing:
2.35
Leverage:
2.2456765
Delta:
0.9674081
Implied volatility:
74.86 %
Moneyness:
73 %
Time value:
0.015
Calculation base price:
17.41




2. This call option is american-style, but not callable so what is the difference between this option and a european-style option?

3. a) Ratio: This isn't the same as in leverage ratio the debt-to-equity ratio, is it? what exactly does it mean?
b) Premium p.a.: what does it mean?
c) Premium: a precentage value of what exactly is this?
d) Remaining life: is this (Remaining Days)/(Lifetime in days)?

4. Why is the break-even that high? And why not instantly excericise such an option if it was possible? (ignoring fees) Wouldn't you pay 10.00 + 0.37 + Premium to get a share worth 17.41, when exercising the option?

As you can see I seem to have misunderstood something very important here ;-)

Thank you very much in advance for your help!

cepheus

newbee2000 wrote: »

Out of curiosity I recently started to trade call options.

I have read a lot about it but when I actually started to buy some using e-banking there where some things I didn't completly understand.

If an american-style call option ist deep in-the-money e.g. spot-price == 20$, strike price == 10$ (ignoring interest and fees in this example) why should I not just excercise the call?

The simple answer is because the option price might increase more if the underlying share price or volatility increases, if you don't think it will then you sell it. I understand that options contracts themselves are normally just traded and are rarely actually called and converted until very near expiry. Presumably because it is cheaper this way.

Just because an option is in the money doesn't necessarily mean it is the right time to trade or exercise it. Just like shares an option price just represents fair value in the opinion of the buyers and sellers. Over the short term it will usually tend to go up and down in tandem with the share price and its expected future volatility

There is usually a healthy premium on the price of an option contract that allows for the time value (you can think of this being the price people are willing to pay for the price of the contract having unlimited upside but limited downside) which will dwindle to zero as the option reaches expiry.

Get a general feel for the numbers, not only what they mean, but how they vary in relation to the underlying market characteristics and time to expiry before trading these. It might also be worth reading more on any peculiarities of trading foreign options.

newbee2000

Firstly, thank you very much for your answer.

I understand that options contracts themselves are normally just traded and are rarely actually called and converted to shares until very near expiry.

I have read that many times, but it never really said why. And since the intrinsiv value is that much higher than the strike price + premium (as in the example above) I don't get why not just exercise the option.
ca. 60% are bought back, 30% are not exercised and 10% are exercised. This and many similier statements you can find in almost every book on this topic, but I didn't find yet anything explaining why exactly (e.g. the way to calculate the break-even above). Maybe I have just read the wrong books.

I am not interested in trading the options, but to actually make use of the contract to buy shares at a certain time (to call the option) to a certain price (strike price + premium), which should be possible for american-style options, isn't it?

Tanks for the help!

cepheus

And since the intrinsiv value is that much higher than the strike price + premium (as in the example above) I don't get why not just exercise the option.

I see what you mean. A long time ago I looked at warrants and there were similar anomolies, I guess it is either a misprint, different units or a lack of updating of one figure and not the others. Otherwise I can't imagine why the premium should not be higher.

turbobob

With covered warrants (very similar to options I think) they quote a number for parity, e.g. this Barclays warrant is 1/1 while for comparison this Rio warrant has a parity of 10/1. What this means is that one Barclays warrant is theoretically equal to one Barclays share, however you'd have to buy 10 warrants to be equal to having the rights on one Rio Tinto share. I would guess the ratio you've quoted above (20/1) has a similar meaning.

4. Why is the break-even that high? And why not instantly excericise such an option if it was possible? (ignoring fees) Wouldn't you pay 10.00 + 0.37 + Premium to get a share worth 17.41, when exercising the option?

If you work it out the strike price and the price of the option (or 20 options if the point about the ratio is correct) should be higher than the underlying, because of the remaining time value etc. If you could simply do what you described, don't you think everyone would do it? AFAIK the reason most people would buy in the money options or warrants is because of the inherent leverage

newbee2000

If you could simply do what you described, don't you think everyone would do it?

Yes, I do and this is exactly why I didn't get it :P

Your hint about the ratio was correct as I learnt today and it explains about 99% of my questions . Thanks a lot!