Calendar Spread

Discussion in 'Options' started by ahollybair, Oct 4, 2007.

  1. Hi Guys:

    I've been trading stocks for 10 years or so.
    I'm new to Options trading: actually trying to setup a calendar-spread trade, but ran into a situation that can't seem to get a clear answer to.

    Here is the trade:
    (a) I want to Sell short term (Oct 2007, Nov 2007, Dec 2007) PUTs for income.
    (b) To cover myself I Buy LEAPs (Apr 2008).
    (c) Same Strike Price, Same qty underlying.
    (d) If for some unplanned event, the price of the underlying hits the Strike price of the short-call, I'll be automatically assigned.
    (e) I will be required at that point to cover the underlying that was PUT to me.
    (f) I don't have the cash to cover it.
    (g) My understanding (from seminars, books, etc) is that you can cover yourself by buying far-out options.
    (h) So I use my LEAP options to cover my short option.
    (i) However, from my conversations with the broker, I am 'naked' for a about 24hrs, until I exercise my LEAP and cover myself.

    QUESTION:

    (q1) Is it correct that you are not really covered by the LEAP,
    (q2) and you really need the funds to cover yourself for the short option ?
    (q3) So what good is the LEAP if you are not really covered.

    thanks.

    Ahollybair
     
  2. There are some errors in your post. Most are minor.

    Some clarifications:

    b) To cover myself I Buy LEAPs (Apr 2008)

    Those are not LEAPS. LEAPS have more than 9 months remaining.

    (a) I want to Sell short term (Oct 2007, Nov 2007, Dec 2007) PUTs for income.
    (b) To cover myself I Buy LEAPs (Apr 2008).

    This is a put spread.

    (d) If for some unplanned event, the price of the underlying hits the Strike price of the short-call, I'll be automatically assigned.

    There are no calls involved in a put spread. Typo?

    (e) I will be required at that point to cover the underlying that was PUT to me.

    That's not true. If there's time premium remaining, the holder of the call gets more for it by selling it to close than by exercising it. At the strike, there will be TP remaining unless it's hours before expiration. You'll have plenty of time to adjust your position before that happens.

    (g) My understanding (from seminars, books, etc) is that you can cover yourself by buying far-out options.

    Correct, You can buy nearer term too.

    (i) However, from my conversations with the broker, I am 'naked' for a about 24hrs, until I exercise my LEAP and cover myself.

    You're not naked. For margin purposes, your short put is deemed covered because you own a call that has the same expiration or later and the same strike or lower. Once the short put is exercised, you have a margin issue due to insufficient cash for buying the stock.

    Exercising your LEAP to cover yourself is not a good idea because you're throwing away its time premium. AFAIK, you can sell the assigned stock and then sell the long option to close. Having never been in this position, I won't swear to it so I'm wrong, a more knowledgeable poster will chime in.

    For calendars, give some thought to buying long legs that have a closer expiration. With an April, your net debit is higher and that increases your dollar risk should the underlying move significantly away from the strike.
     
  3. MTE

    MTE

    I think the first step is to clarify what he/she is actually trading, is it call calendars or put calendars!

    Shorting puts and buying calls is a synthetic long stock! It's not a calendar!

    If the stock is at the strike that doesn't automatically mean an assignment!

    Assuming we are talking about put calendars, then if the short put is assigned and you don't have the funds to cover the stock position then you will be issued a margin call and you will either have to deposit more money, close the stock position or exercise the longer term put (this would be last choice as you lose the time value by exercising).
     
  4. Sashe

    Sashe

    If you don't have cash to cover your assignment just close your assigned stock, though it's unlikely someone put it you unless this is right before the exp or very DITM. I also agree with the previous poster saying that better use a closer month ( I use the second or third) for the long leg than a LEAP.
    If someone figured how to managed gammas with the calendars, please post your ideas.
     
  5. spindr0:

    thanks for explanation. Yes 'call' was a typo; it's a PUT calendar spread trade.

    re LEAPs: thanks for the clarification.

    MTE: your last paragraph - "... then you will be issued a margin call...." - is what I was concerned about in the first place: I realise that I am not completely naked, and that I can eventually cover myself via my long PUT positon.

    However, I don't like the idea that there is no automatic method to cover myself, other than having the large amount of cash in the account. It would be nice to have a One-triggers-other trade setup.

    I don't like the idea of having to cover the situation by my manual intervention: I could be unreachable for 24hrs, my internet access could be down....

    As to assignment: my understand is that by OCC rules, if you are $0.05 in-the-money, then you are automatically eligible for assignment. It is true, you may not necessarily be assigned, but there is no guarantee you will not be either. I just want to cover myself for the worst case scenario.


    Is my understanding correct ?
     
  6. spindr0: thanks for the sage advice last paragraph of your post.
     
  7. Seems to me that a long put of any duration will cover 100 short shares, and the net amount of maintenance for the position will depend on the strike price and moneyness of the put. Since the calendar should have zero maintenance requirement, you may have issues if your account is close to being offside already (because the assignment will cause a sudden jump in the maintenance requirement), but the total maintenance for 100 shares short and an ATM long put should be small.

    Make sure your broker understands the position you are describing, and consider looking for another broker if you find that margin requirements vary significantly. This isn't the sort of thing you want to learn by surprise.

    The problem with exercise and assignment is that you get assigned overnight and you can't make the reactive decision to exercise the long leg till the following morning. There will always be a day's lag between those two events.

    The good news is that puts are basically never assigned early. It's really more of a theoretical risk. Also, if your put drops so far ITM that you're at risk of early assignment, you may as well close out your calendar because it will be worthless and future writes will not be profitable anyway.

    Automatic assignment happens on expiration day only. That's the Saturday after the third Friday of the month. Even so, there's some discrepancy between brokers, and the holder of the option may elect not to exercise any ITM option.

    As long as you close out ITM short put positions a day or two before expiration, you will pretty much always be safe from assignment.

    Calls are another story.
     
  8. u21c3f6

    u21c3f6

    Puts are assigned early all the time when they are DITM.

    If assigned, you could also close your position by selling both the stock and your long put (married put).

    Joe.
     
  9. Or you could just sell the real call and get a lock.
    db
     
  10. Stop worrying about early assignment. If there's time premium remaining in the short put, it's highly unlikely that it will be assigned early.

    As MTE suggested, if you don't have the funds to cover the stock position then you will be issued a margin call and you will either have to deposit more money, close the stock position or exercise the longer term put (this would be last choice as you lose the time value by exercising).

    If your concern is being out of touch for 24 hours, then you should be dealing with a broker who also has a land line. I'm more concerned with my broker's server going down so I maintain another small account that can be funded quickly and transacted to cover the primary account. But this isn't about me, is it? :)

    And even if you are incommunicado for 24 hours after assignment, with a margin call, your broker is going to step in and either sell the shares or exercise the long put to cover the assignment. I wouldn't be very happy about the latter since that's the worst choice for you.

    In general, by the time that your short put has no time premium remaining, you've waited too long. You should be moitoring the position every day and once it goes in the money, watching it even more carefully because then you are risking the TP of the long leg.

    As for $0.05 OCC assignment rules, that's for expiration, not for daily trading/
     
    #10     Oct 6, 2007