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Options On Expiry

2020.06.03 OKEx Academy

In the last episode, we talked about how to calculate PnL when you close your positions before expiry. In this episode, we will move on to calculate PnL of options on expiry.

First, we need to understand what is exercising options. If a user buys a call option or a put option and holds it until expiry, it may be exercised. This can be regarded as OKEx futures settlement. However, unlike futures which must be settled upon expiry, options may not be exercised upon expiry. It depends on their values upon expiry to trigger exercise.

An option with intrinsic value is called an in-the-money option, which will be exercised on its expiration date, while an option without intrinsic value is called an out-of-the money option, which will be invalidated on its expiration date. Then, how to define an option with intrinsic value?

For example, Allen sells a basket of apples to you for $100, but their market value is $105. You made a good decision because it is $5 cheaper to buy from Allen. If we change the basket of apples into an options contract, Allen is the options seller, and you are the options buyer. The contract is valuable to you because the seller promises to sell it to you at a lower-than-market price, so that you choose to buy.

But what if Allen decided to sell the basket of apples to you at $110, will you still buy from him? The answer is no, because the market price is only $105, it’s not a good deal to buy apples from Allen. The same applies to options contract, if the contract have no value to you, you will not buy it.

A call option gives the buyer the right to buy an agreed quantity of an underlying asset at a set price, while a put option gives the buyer the right to sell the same at a set price. Upon expiry, if the options contract is valuable to the buyer, he will exercise it; if not, he will not.

Next, how to calculate options PnL upon exercise? The gain is equal to the profit you gain minus the premium you pay during trading. Let’s go back to the last example. You buy a basket of apples at $100, $5 lower than the market price of $105. That means you gain $5 from the deal, or the contract. Then, if you buy the apples, or the contract, without paying extra money, your exercise gain is $5.

So, how to calculate exercise PnL during BTCUSD options trading on OKEx?

If you buy 2 BTCUSD-20200214-9500-C contracts at 0.004 BTC on Feb 1, you have the right to buy 0.2 BTC at $9,500 on Feb 14, 2020. You have held those two contracts until 08:00 on Feb 14 (UTC), which is the expiry time. Upon expiry, if BTCUSD rises to $10,000, which is higher than the strike price of $9,500, it is worth exercising because you can buy BTC at $500 cheaper. The contracts will be automatically exercised on the platform. You, as the buyer, will receive an exercise gain of 0.0092 BTC, which is calculated as the gain [(10000-9500)/10000*0.1*2] minus the premium paid on Feb 1 (0.004*0.1*2).

Upon expiry, if BTCUSD rises to $8,000, which is lower than the strike price of $9,500, it is not worth exercising because you’re buying BTC $1500 more expensive than the market price. Therefore, the contracts are OTM, which will be invalidated upon expiry, after which you cannot receive any exercise gain. Given the premium you pay on Feb 1: 0.004*0.1*2 = 0.0008 BTC, your exercise loss will be 0.0008 BTC.

If you sell 2 BTCUSD-20200214-9500-C contracts at 0.004 BTC on Feb 1, you have the right to sell 0.2 BTC at $9,500 on Feb 14, 2020. You have held those two short contracts until 08:00 on Feb 14 (UTC), which is the expiry time. Upon expiry, if BTCUSD rises to $10,000, which is higher than the buying price of $9,500, it worth the buyer, your counterparty, to exercise the contracts because he can buy BTC at $500 cheaper. Therefore, the contracts are ITM, which will be automatically exercised on the platform. You, as the seller, will pay the BTC value of the contracts to the buyer. Your exercise loss will be 0.0092 BTC, which is calculated as the gain received on Feb 1 (0.004*0.1*2) less the premium {(10000-9500)/10000*0.1*2}.

Upon expiry, if BTCUSD is $8,000, which is lower than the buying price of $9,500, the contracts are of no value for the buyer, your counterparty. Therefore, the contracts are OTM, which will be automatically invalidated upon expiry. You will need not to pay anything to the buyer. Given the premium you receive on Feb 1: 0.004*0.1*2 = 0.0008 BTC, your exercise gain will be 0.0008 BTC.

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