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Special Concerns for Option Traders
By: Rick Thachuk   Wednesday, August 8, 2007 11:27 PM
In cases where it is difficult to offset a losing option position on an exchange, the option grantor will be subject to the full risk of their positions until the options expire.

Liquidity Concerns
Exchange trading mechanics are designed to provide for competitive execution and to make available to buyers and to sellers a continuous market in which an option once purchased can later be sold; and in which an option, once granted, can later be liquidated by an offsetting purchase. Although each exchange's trading system is designed to provide market liquidity for the options traded on that exchange, there can be no assurance that a liquid offset market on the exchange will exist for any particular option, or at any particular time, and for some options no offset market on that exchange may exist at all. In such an event, it may not be possible to effect offsetting transactions in particular options. Thus, to realize any profit, a holder will have to exercise their option and have to assume all risks and to comply with margin requirements for the underlying futures contracts or, in the event of an option on a physical commodity, incur the costs and risks of holding the physical good. A grantor could not terminate their obligation until the option expired or they were assigned an exercise notice. You may exercise your option but be unable to liquidate your resulting futures position because of daily price limits or lack of liquidity in the futures market.

Price Limits
The individual should be aware that an option may not be subject to daily price fluctuation limits even if the underlying futures has such limits and, as a result, normal pricing relationships between options and the underlying futures may not exist. Also, futures positions assigned as a result of an expiring option may not be capable of being offset if the underlying futures is at a price limit.

Deep Out-of-the-Money Options
A person contemplating the purchase of a deep out-of-the-money option (that is, an option having a strike price significantly above, in the case of a call, or significantly below, in the case of a put, the current price of the underlying futures contract) should be aware that the chance of such an option becoming profitable is ordinarily remote. On the other hand, a potential grantor of an out-of-the-money option should be aware that such options normally provide small premiums while exposing the grantor to all of the potential losses of an option sale.

Other Risks
The grantor of a call option who does not have a long position in the underlying futures contract, that is, the case of a naked sale or short, is subject to risk of loss should the price of the underlying futures be higher than the strike price of the option, and this loss may exceed the premium received for the initial sale of the call option. The grantor of a call option who has a long position in the underlying futures, that is, the case of a covered sale or short, is subject to the risk of decline in price of the underlying futures, less the premium received for granting the call option. In exchange for the premium received, the call option grantor gives up all of the potential gain resulting from an increase in the price of the underlying futures above the strike price of the option. The grantor of a put option who does not have a short position in the underlying futures contract, that is, the case of a naked sale or short, is subject to risk of loss should the price of the underlying futures be below the strike price of the option, and this loss may exceed the premium received for the initial sale of the put option. The grantor of a put option who has a short position in the underlying futures, that is, the case of a covered sale or short, is subject to the risk of a rise in price of the underlying futures, less the premium received for granting the put option. In exchange for the premium received, the put option grantor gives up all of the potential gain resulting from a decrease in the price of the underlying futures below the strike price of the option.


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