Interesting article from WSJ on Puda Coal (OOTC:PUDA) options:
Stock Halt Tests Options Traders: Exercise or Let Expire?
Options traders who sunk money into puts and calls on little-known Puda Coal Inc.'s stock have found themselves in financial limbo since the stock was halted this past week.
The dilemma: They can let what in some cases could be very profitable contracts expire without making any money, or order brokers to act without knowing where the stock will open. The big problem is that shares could face a huge swing from where it last traded at $6, and that could wreak havoc on options timed for April, May, and onward.
This scenario is now playing out with Puda and other small-cap Chinese companies whose U.S. shares have been halted in recent weeks after allegations of improper bookkeeping. Others facing a similar plight include TV-advertising network China MediaExpress Holdings Inc., fertilizer maker China Agritech Inc. and Shenzhen-based Universal Travel Group.
Nearly half of all Puda's puts and calls will cease to exist after Friday's session.
"A lot of people aren't prepared," Joe Harwood, manager of investor services at industry-clearing body OCC said of prolonged stock halts. Mr. Harwood fielded troubled investors' calls on the subject this past week. "Sometimes you just can't tell. All of a sudden, boom, it's halted." OCC is the rebranded name of the Options Clearing Corp.
The first batch of options to expire since the halt occurred on Friday. The April expiration for Puda and other Chinese companies means investors were forced to decide whether to "exercise" their right to buy or sell the stock, without knowing exactly what the shares' value is. Choosing not to exercise the options would mean simply walking away from the investment altogether.
"You're flying blind," said Brian Overby, senior options analyst at brokerage TradeKing.
Consider the predicament of traders who hold one of Puda's most heavily traded April contracts. These April $10 puts to sell stock were used to bet on a drop in the shares or hedge against that outcome. The puts would be very profitable if shares eventually resume near the halted price of $6, or fall lower.
But, a surge in the stock could cost traders dearly. Nearly half of all Puda's puts and calls will cease to exist after Friday's session when the contracts expire. The next round of options to expire is set for May 20.
There are other quirks. Profitable or "in the money" options are usually exercised automatically at expiration. But OCC's guidelines for stock halts say traders must specifically instruct their brokers to exercise their contracts or else they let the options expire unexercised.
In recent months, dozens of small Chinese companies have faced accounting questions, allegations of fraud and other problems, especially those that gained U.S. listings through backdoor "reverse mergers" that avoid regulatory scrutiny. The Securities and Exchange Commission is investigating some Chinese companies and has established a task force that is conducting a broad probe of how U.S. lawyers, bankers and auditors are helping to bring the companies onto U.S. markets.
At Puda, the New York Stock Exchange halted the shares April 11 after its chairman, Ming Zhao, was accused of unauthorized stock transactions. It could be weeks or even months before the NYSE allows the company to begin trading again.
A Puda spokeswoman said that the company's investigation into the chairman's transactions "has just begun."
The regulatory probe has rippled through financial markets, where investors hold thousands of U.S.-listed options on stocks that have benefited from a zeal for high-growth China. It poses a particular problem for options traders, who make bets on where a stock price is headed over various time periods.
The OCC's Mr. Harwood said all traders should familiarize themselves with the rules that apply to cases of stock halts, and should always make a decision at exercise. Above all, they should stay in touch with their brokers. "I can't stress enough that the client and the brokerage firm need to have some sort of communication," Mr. Harwood said.
Many Chinese small-cap stocks "have been good trade from an options trader's perspective over the last few months," TD Ameritrade chief derivatives strategist Joe Kinahan said, mostly because of how volatile they are. The price the market assigns to volatility becomes richer.
More volatility opens the chance of making quick profits or to "sell" volatility to make money.
Puda's stock traded near $17 in December, but plunged to $6 as the accusations mounted.
The allure of investing in companies in high-growth China was the other obvious draw. "The fear factor has diminished in terms of playing [Chinese] stocks," Mr. Kinahan said. And on China's economic growth, he said, "It's crazy. It's the game in town right now."
The problem is set to recur next month if stock trading isn't resumed. Traders hold tens of thousands of May options contracts outstanding on Puda, China MediaExpress and Universal Travel.
—Michael Rapoport contributed to this article.
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