Hello- when an option contract is closed at the intrinsic value, is that the same as letting the option expire?
Great question, @Marcos. Thanks for reaching out!
Closing a contract at intrinsic value means the option is being traded prior to expiration. For example, let’s assume a long 50 call is purchased for $5. The market price rises to $52, and the contract is closed at intrinsic value. This means the investor performed a closing sale of the call, or simply sold the call to another investor. When we say “close at intrinsic value,” we mean the option is traded at a premium equal to the intrinsic value. At at market price of $52, the 50 call has $2 of intrinsic value. This chapter discusses how to determine intrinsic value on an option.
So, what exactly happened in the example above? Let’s detail it here:
|Closing sale (sell the call)||+$200|
It’s possible you saw a similar question where the option was closed, but didn’t have intrinsic value. For example, let’s again assume a long 50 call is purchased for $5. However, this time the market price falls to $47, and the contract is closed at intrinsic value. At $47, the 50 call has no intrinsic value, and is essentially being sold for nothing. Let’s detail how it would look:
|Closing sale (sell the call)||+$0|
It’s scenarios like the one above that could make it seem like closing a contract means the option is expiring. Essentially, the overall loss is the same whether it was closed or allowed to expire. These scenarios are hypotheticals FINRA may use to test your knowledge of intrinsic value. Visit this chapter to brush up on the concept of closing contracts.
Bottom line - closing contracts and expiration are two different things.
I hope this helps! Please let me know if you have any more questions.
@brandonrith, thank you for clarifying the difference between closing an option at the intrinsic value and letting it expire. Your detailed examples are exactly what I need to fully comprehend the concepts!