If You're Caught Holding Halted Options

I own some put options on a stock. What happens if the stock is halted for trading? Of course, I know that the options won't trade. But assuming that a halt continues through option expiration this month, can I exercise my put option into a short with the stock halted? Someone told me that I was at risk because if I can't exercise the option because of the halt, then my option, although it is in the money, will expire worthless. Is that true?

A great resource for finding answers and information on just about anything to do with options is the Options Industry Council Web site. If you have a specific question, especially regarding trading procedures and rulings, you can telephone 1-800-OPTIONS and pose your question to a live OIC staff person. I made that call and received the following answer to the question above.

"When a stock is halted trading for any reason, the related options are also halted. But the right exercise remains intact," said Jeff Huddlyston of the OIC.

The reasoning for allowing the exercise of an equity option (remember most equity options are American-style and can be exercised at any time prior to expiration) is rooted in the fact that an option is deemed a binding contract and as such the buyer retains all the rights, and the seller the obligations, that are implicit in that contract.

If an exchange or regulatory body were to nullify, restrict or greatly alter that right, such as through an extension of the expiration date, it would constitute a breach of contract and a violation of the original terms of the agreement between the buyer and seller. Note that an options contract does not guarantee the right or obligation to buy or sell (trade) at all or any time during the life of the contract.

What to Do

Of course, if a stock is halted pending news and doesn't reopen through the Friday of expiration (equity options cease trading the third Friday of the month but don't technically expire until Saturday) the owner of an option can be faced with a very difficult decision: to exercise or not to exercise.

In some cases there might be sufficient information regarding the halt to give the holder a pretty good handle on whether the stock is likely to reopen significantly higher or lower. That, of course, would determine the merit of exercising the option.

In fact you could conceivably have enough information that it would make sense to exercise a put that was well out of the money when trading was halted if you are fairly confident that the stock will reopen significantly lower, causing that put option to move into the money. That is a highly risky move, though, because there's the risk that the market, especially when given time to reassess all the ramifications of the event that caused the trading halt, will not respond as initially expected.

Note that because most index options such as the S&P 500 are cash-settled and cease trading on Thursday, the decision to exercise is much easier. The cash settlement means your account will be debited or credited by the appropriate dollar amount and will have no outstanding position beyond the expiration. The exercise of an equity option on the other hand could result in creating an outstanding long or short position in the underlying shares, which will be held or carried until the stock reopens for trading.

Knowledge Pays Dividends

Dividends offer another example of why it makes sense for option owners to retain exercise rights on halted stocks. The OIC's Huddlyston cited the situation during the week of Sept. 11, 2001, in which the entire equities market remained closed for four days. While it was not an expiration week, several stocks, most notably Altria ( MO) (aka Philip Morris), went ex-dividend during that period. It was important for call option owners to be able to exercise if they wanted to be a holder of record and qualify for the quarterly dividend payment.

Huddlyston added this insight on options on companies that declare bankruptcy. He said that options will indeed continue to trade as long as the underlying shares remain publicly traded, even if it is only the the over the counter or bulletin board market. Once a company's shares are set for a complete delisting, the options will remain open to facilitate closing transactions for a specified period of time.

What are some good sources -- both books and Web-based -- where I can learn more about delta-neutral, volatility-based and other trading strategies?

To paraphrase movie critics: If you were to read just one options book this year, you can't go wrong with Sheldon Natenberg's Option Volatility & Pricing: Advanced Trading Strategies and Techniques. It remains, if not the definitive, one of the best and most popular books on options, combining both theory and application.

For a slightly more investment-oriented book, I would recommend Options as a Strategic Investment by Lawrence McMillan.

I'll also repeat the suggestion above that everyone should take advantage of the Options Industry Council Web site and hotline. The OIC has no agenda and is totally agnostic in that it does not promote any specific strategy, exchange or firm over another. Its only mission is to spread the word regarding how letting options into your trading practices can provide a more rewarding investment experience.

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Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to steve.smith@thestreet.com.

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