1
$\begingroup$

Problem:

  • Deep in the money options contracts will be assigned at expiration date.

  • Higher Volume ratio of deep in the money contracts at expiration calls or puts leads to day after expiration date we have more traders holding the underlying asset or disposing based on calls to put ratio below or above 1.

  • Assumption: "The day after expiration date the more traders being assigned the underlying assets the more likely after expiration the asset will have an edge to the downside."

  • Conclusion: It is advantageous of being long or short the underlying asset based on the volume of options assigned at expiration date.

Question:

Does this make any sense? Is there any paper research on this topic?

Improve this question
$\endgroup$
  • 1
    $\begingroup$ I agree a high delta will make the option lock-step with the underlying asset this we all agree on. But My main point is when a large number of options will be assigned at expiration this will lead to a biased move to the opposite direction of the assigned options. $\endgroup$ – Options Trader Mar 11 '19 at 1:20
  • 1
    $\begingroup$ I do use it in real life trading top 10 liquid etfs. They have huge one sided positions some of the time. $\endgroup$ – Options Trader Mar 11 '19 at 3:45
  • 1
    $\begingroup$ As to the biased move in the oppoiste direction if this does not happen then the market will be unstable. It will wipe out market makers and all those brokers who take opposite positions to provide liquidity. It will be extreme market conditions. Does this make sense. $\endgroup$ – Options Trader Mar 11 '19 at 3:48
  • $\begingroup$ Yes. But how do I know if this luck, chance, biased personal opinion or there is something solid behind the idea. Im not sure, but i know people before me have thought of everything. Only need to know what wording are used to describe the issue and what terms are used in technical papers. Google is returning nothing related. $\endgroup$ – Options Trader Mar 11 '19 at 4:15
4
$\begingroup$

I don't mean to suggest such a large topic, but it would certainly be worth reading about delta-hedging with regards to your question.

Since such a large percentage of options are delta-hedged, the net price change of shares in the underlying due to exercise on expiration would be ~0.

As @Emma mentioned, deep in the money options have a high delta. This leads to a large ratio of an opposite & offsetting position in shares being put on immediately.

Example:

Buy to open one SPY 100 Call, Delta ~0.98

Counterparty sells to open the option and immediately buys 98 SPY shares.

As expiration approaches, delta will approach 1. As it hits 0.99, an additional share will be bought. As it hits 1 (near expiration), only a single additional share will be bought.

The delta-hedging counterparty will then own 100 shares as the call is exercised and the 100 shares are assigned to the option buyer.

In answer to your question, essentially any benefit that might have been gained at expiration has been distributed throughout the life of the option contract.

The changes in these offsetting positions are more pronounced at lower deltas, but in-the-money options will always end in a delta of 1. They will have been continuously adjusted and will therefore have a fully offset position by their expiration date.

Improve this answer
$\endgroup$
  • $\begingroup$ "In answer to your question, essentially any benefit that might have been gained at expiration has been distributed throughout the life of the option contract." This is not true if we need to look at a date in the future, that is I am more interested in the after affect a day after expiration when a huge number of options are assigned the underlying asset will have either more entry positions of buyers or sellers at the stricke price. I know its mind boggling sometimes thinking about the subject. $\endgroup$ – Options Trader Mar 11 '19 at 1:25
  • $\begingroup$ However, consider the assignment/exercise process: Even non-delta-hedged transactions are cleared through the exchange with a predetermined price. They never hit the market and therefore do not move said market. There is not an imbalance of buyers/sellers. Each contract has both sides of the trade pre-established. Buyers have pre-arranged sellers and vice versa. Definitely a mind boggling subject, yes. $\endgroup$ – MonteCarloSims Mar 11 '19 at 2:02
  • $\begingroup$ Time to bring the debate among armchair theoreticians to an end and to start collecting empirical data as to whether this phenomenon affects option returns or not... $\endgroup$ – Alex C Mar 11 '19 at 2:05
  • $\begingroup$ quantpedia.com/screener/details/102 Here is some supporting empirical evidence to suggest that options returns, in fact, could be affected during the week prior to expiration as due to large directional bias and delta-hedge unwind. This supports my theory that "any benefit that might have been gained at expiration has been distributed throughout the life of the option contract." However, Alex C is correct in that I do not have a definitive answer to what happens to the underlying stock's return after expiration. Hopefully the link above shows what it would take to prove with model $\endgroup$ – MonteCarloSims Mar 11 '19 at 2:33
  • $\begingroup$ Thank you Daniel for sharing the link. Its intresting for me to study further. $\endgroup$ – Options Trader Mar 11 '19 at 3:54

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.