Hi Liane,
You are correct there are only two ways that open interest can decrease. The first is for someone that is long to sell his contract and on the other side of the trade for someone that is sort to buy the contract. This transaction will cancel one contract. The second is for a long to exercise his option.
The Jan 2014, $5 call are quoted 1.47-1.50 and MNKD is quoted 5.34-5.35. If you think about trying to close a long position, you can exercise it and then sell the stock. This will produce $0.34 in cash. But selling the option will produce $1.47, so there is no way it will be exercised.
My conclusion is open interest decreased because investors are closing their contracts by entering into offsetting trades.
So, your question is why are longs and shorts suddenly closing their contracts?
One reason a short may want to close his position is if he holds it as part of a strategy – either a vertical call spread (long the $2 strike and short the $5 strike) or as a covered call (long the stock and short the $5 strike) – there is not enough remaining upside return left in the strategy when the stock price is at its current level for the perceived level of risk. Instead of holding it for limited additional return and taking the risk that something goes wrong, it might be prudent to sell the strategy before the release of data.
For the longs, it seems like if they paid $0.20 and can exit now for $1.47, they have made a nice profit and may not want to take a risk waiting for data. Also, a holder of a long 2014 call may want to roll it over to a 2015 call. If he has conviction that the price will go up after the 2014 expiration, it may make sense to roll now. Remember that each day of time decay increases as you approach expiration.
Also, closing a position now, instead of exercising may have tax benefits. If the option was held for over a year, the gain is long term, but if it is exercised, the investor has to wait a full year to sell the stock for the gains to be treated as long term.
One last point is that most option contracts are closed before expiration. Most people do not want to take delivery.
I do agree with you that it seems a little strange to see the open interest decrease at this point. I would have expected it to happen a little later.
Bob
