Options Forum: Pros Have Expiration Edge

I'm currently long a Google(GOOG Quote) put spread. I've been calculating the option values given different scenarios, different stock prices, time to expiration, etc. One thing that jumped out at me was that Google options, especially if they are trading right at the strike, tend to maintain a slightly positive yet material value, right up until zero days left. For instance, with much less than an hour left, they still can be valued at 30 cents to 50 cents.

I need to decide at what point I'm going to cover the short puts, or whether to let them expire. Will the options that are close to the money retain some positive time value at the close on Friday?

Ideally, I'd like to close the position out for its maximum profit of $10, but I may end up taking less (assuming the trade goes my way) depending on how the options retain time premium. Thanks very much for your insights. -- S.M.

All at-the-money options, not just Google's, will retain some value right into the cessation of trading on the final Friday in the life of the contract. One of the reasons is that equity options technically do not expire until the following Saturday morning. This means that any news released after the close could influence option owners' decision to exercise the option, even if it was out-of-the-money on the basis of Friday's closing price.

But for the average investor, the risk/reward of carrying an option position until expiration rarely makes sense.

Treacherous Waters

The trading floor is littered with the wreckage of investors who have tried to steer or dock their positions at the maximum profit point that can be realized only at expiration. As expiration approaches, navigating a position becomes infinitely more risky and difficult. This is because the time decay accelerates the options' gamma, or increases their sensitivity to changes in the price of the underlying. This in turn makes the positions' value more akin to holding the stock but trading in the less-liquid options market.

While electronic markets have made the playing field pretty level, "the statistical edge swings totally toward the professional trader once you get to the last week of trading," says Tom Sosnoff, the CEO of ThinkorSwim, an online brokerage firm specializing in options trading.

For options that have 30 days or more remaining, a patient customer can be fairly confident that he can get orders executed at fair market value. The multitude of variables makes the option's ultimate or true value hard to pinpoint, and that makes it more difficult for professionals to accurately hedge or arbitrage the trade for a definitive financial advantage.

But as expiration approaches and the true theoretical value becomes easier to pinpoint, professionals need only a small edge to lock in a risk-free profit. "Resting option orders become sitting ducks for the market makers to lean on and flip a profit," says Sosnoff. He explains that the professionals and market makers simply are more nimble than individuals, and he sees no reason for customers to go head-to-head with professionals.