There is much mystery behind when in-the-money (ITM) options get executed. In this article, we will break down the different scenarios in which ITM options get executed, and we will also provide tips on avoiding getting your ITM option executed.
What are in-the-money (ITM) options, and why do they get executed?
In the money (ITM) options are strike prices below the current market price for call options and above the current market price for put options. There are two main reasons why investors might execute their ITM options:
- To take advantage of intrinsic value- Intrinsic value is the amount by which an option is in the money. In our example, the intrinsic value of the $45 call option is $5 per share ($50 market price minus $45 strike price). If the option is close to expiration and has significant intrinsic value, the investor might exercise the option to buy or sell the underlying stock at a favourable price.
- To avoid paying taxes- When an investor sells an ITM option, they are subject to being taxed as though they sold the underlying security. However, there is something called the wash sale rule, which states that an investor cannot deduct a loss on the sale of a security if they repurchase the same security within 30 days.
For example, if an investor bought a call option for $5 per share and it expires ITM, the investor would have to pay taxes on their $5 per share profit. If investors do not want to pay taxes, they can exercise their ITM option and avoid the wash sale rule.
When do in-the-money (ITM) options get executed?
In-the-money (ITM) options can get exorcised at any time up until expiration. However, there are certain circumstances when investors are more likely to exercise their ITM options.
Some common scenarios when ITM options might get executed are:
- When the option is close to expiration– If an option is close to expiration and has intrinsic value, the investor might exercise the option to take advantage of the favourable price.
- When the underlying security is about to pay a dividend– If the underlying security is about to go ex-dividend, the investor might exercise their ITM call option to receive the dividend.
- When the investor is subject to the wash sale rule– If the investor does not want to pay taxes, they might exercise their ITM option to avoid the wash sale rule.
How can you avoid getting your ITM option executed?
If you don’t want your ITM option to get executed, there are a few things you can do.
- One way to avoid getting your ITM option exorcised is to keep it until expiration. If you hold an ITM option until expiration, you will have the opportunity to either sell it or let it expire worthless.
- Another way to avoid exercising your ITM option is to roll it over. When rolling over means closing out your current position and opening a new one, which can be done by buying or selling options.
- Lastly, you can avoid getting your ITM option exercised by hedging your position. Hedging means taking an offsetting position in another security. For example, if you are long an ITM call option, you could hedge your position by buying put options.
What are some of the risks associated with ITM options?
There are a few risks associated with ITM options:
- One risk is that the option might get executed, and you might have to pay taxes.
- Another risk is that the option might get executed, and you might not be able to take advantage of the intrinsic value.
- Lastly, there is always the risk that the option will expire worthlessly.
What are some of the benefits of executing an ITM option?
There are a few benefits of exercising an ITM option. One benefit is that you might be able to take advantage of the intrinsic value. Another benefit is that you might be able to avoid the wash sale rule. Lastly, you will have the opportunity to sell the option or let it expire worthless.
How can you avoid getting stuck with an unexecuted ITM option?
You can do a few things to avoid getting stuck with an unexecuted ITM option. One thing you can do is keep the option until expiration, and another thing you can do is roll it over. Lastly, you can hedge your position.