Abandon (Options Trading)
In the context of options trading, the term "abandon" refers to the decision by an options holder not to exercise or offset a long option position. Abandoning an option means choosing not to take further action regarding the option contract, typically because it is not financially advantageous to do so.
Abandonment of Options
Options contracts give the holder the right, but not the obligation, to buy (call options) or sell (put options) the underlying asset at a predetermined price, known as the strike price, before or on the expiration date. When a trader holds a long option position, they have the choice to exercise the option, offset it by selling the same contract, or simply let it expire without taking any action. Abandonment occurs when the holder decides not to exercise the option or offset the position.
Factors Influencing Abandonment
Several factors influence the decision to abandon an options contract:
In-the-Money vs. Out-of-the-Money: Options are classified as either in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM). Traders are more likely to exercise or offset ITM options because they have intrinsic value, while OTM options are typically abandoned since they lack intrinsic value.
Transaction Costs: The costs associated with exercising or offsetting an option, including brokerage fees and commissions, can impact the decision. If the costs outweigh the potential gains, abandonment becomes a more attractive option.
Time Remaining: As options approach their expiration date, their time value decreases. If an option has little time value left and is OTM, it is often more cost-effective to abandon it rather than incur transaction costs.
Market Conditions: Current market conditions, including volatility and the price of the underlying asset, may affect the decision to abandon or exercise an option. High volatility can make options more valuable, while low volatility can render them less attractive.
Investment Strategy: A trader's overall investment strategy and risk tolerance play a significant role in determining whether to abandon or exercise an option. Some traders may prefer to minimize risk by avoiding unnecessary transactions.
Implications of Abandonment
Abandoning an options contract has several implications:
Loss of Premium: The options holder forfeits the premium paid to acquire the option. This is the cost of holding the option and represents the maximum potential loss.
No Ownership of Underlying Asset: By abandoning an option, the trader gives up the opportunity to buy or sell the underlying asset at the strike price. This can be advantageous or disadvantageous depending on market conditions.
Avoiding Transaction Costs: Abandonment can help traders avoid transaction costs associated with exercising or offsetting options, especially when the potential benefits are limited.