Derivatives - Closing Transactions
By definition, a closing transaction reduces or eliminates a long position and a short position.
An option can close in one of two ways:
- Exercise, in which the option holder elects to put into effect the rights that the instrument confers.
- Expiration, in which the option just runs out of time.
- Upon exercise, the buyer sends the writer an exercise notice, sometimes called an exercise assignment, which requires the writer to sell the security in the case of a call option, or to buy the security in the case of a put option, at the specified strike price.
- In the case of expiration, there is no further communication or trading necessary between the holder and the writer; the long and short positions just evaporate.
Reading Options Transactions Shorthand
There is shorthand for expressing options transactions. Let's say you saw this on the Series 7 exam:
1 JKL March 90 call @ 2
You would read that as "a call option on one block of 100 shares of JKL Corp. stock, expiring in March, with a strike price of $90, with a premium of $2 per share".
You would not read that last part as "$2 per block of 100 shares". Still, you can see the appeal of an option: in this example, you take a position on a stock for $2 per share instead of $90 per share. Not only that, but by either buying a put or writing a call, you can bet that the share price will go down; when buying the underlying stock, you can only bet on it going up.
The precise time of expiration is Central time, on the Saturday following the third Friday of the month. An order to exercise must be submitted by Central time on that third Friday.