Hello, I wonder how assignments actually work. I will take a simple example and have put questions 1-5. If it is possible to answer those question as 1-5 would be the best to not mix the answers in one sentence to not confuse. Let's assume below: A. AAPL spot price: 100 B. We sell a call credit spread: -->Sell call at strike 103 for 3 dollar premium. -->Buy call at strike 104 C. It is 50 DTE Let us say, that is has gone 20 days. Now I wonder what happens in below scenarios. I simply wonder if we will be assigned 100 short shares of AAPL. 1. AAPL is trading at 103. (How likely that we will be assigned?) 2. AAPL is trading at 104. (How likely that we will be assigned?) 3. AAPL is trading at 105. (How likely that we will be assigned?) 4. What I have not really understood completely is. Will we be assigned when this call goes ITM and how deep must it go. To really answer this question, what is the % chance of being assigned. What is the actual experience here at above trading prices? 5a. When assigned in this scenario after 20 days. Will we keep the ENTIRE 3 dollar premium and being short 100 shares for 103 dollar? 5b. If 5a is correct. Lets say AAPL is trading at 104 now. That means that we can buy back the shares for 104 meaning that we lost 1 dollar (100 dollars) but we made 3 dollar premium (300 dollar)? 5c. When assigned. We will be short 100 shares á 103 dollar = 10300 dollar. Does this mean that we must have 10300 dollar in real cash on the account as I want to buy back those shares immediately for example 1 second later to be in no position at all. How does this work in reality? I think the buy call should work as a hedge and we only need the strike difference 103-104 = 100 dollar real cash margin? Thank you!
1. Not likely at all (who exercises that early) 2. Not likely at all (who exercises that early) 3. Not likely at all (who exercises that early) 4. 0% chance because still 30 days until expiration. 5a. Yes, but this will not happen since: With and IV of 20, 30 days till expiry, with AAPL at 105, the 103 call still has about 1.50 time value left. AAPL needs to be at something like 130 before there's no more time-value left (put = zero). And even then, no-one would exercise 30 days before expiry. For arguments sake, let's say it's expiration. AAPL at 105. You will be assigned in 103 call. And you will exercise the 104 call. This spread is worth $1. You will not have a stock position, because assignment = exercise. 5b. 5a wasn't really correct... but lets assume it did happen. Yes, this would correct. But also, you're still long the 104 call.... 5c. Depends on your account. You still have the 104 call, so with a portfolio margin account your broker should just lend you the shares. Don't know how much margin to hold exactly, but I'm sure not a lot more than you would have to set the trade up initially. As discussed in your other thread.... when dividend is involved, those calls might be exercised prior to dividend date. And to make it more difficult to understand... in the case of very high short stock interest rates or when stocks can't be shorted, calls can be exercised early as well. Again, depending on what are the costs of keeping and what are the costs of exercising (interest value compared to put-value).
Just to add, If you do get exercised early, you will notice the option and stock have disappeared overnight. Some brokers will alert you to the exercise and some will not. Because you get to keep the premium, it's usually a good thing if they decide to exercise early. Since you own the shares, there is no risk of unlimited losses to the upside. The broker will charge exercise fees. One strategy I like to use, own the shares and sell the ATM straddle. At expiry, if the product is trading above the strike, the stock and options all disappear from your account overnight and the short premium remains in your cash balance. In this instance, you're not required to do anything as the process is all automated by the exchange. The broker will charge exercise fees. If the product closes below the strike price, on expiry, I end up with equal amount of shares recorded at the strike price and no options but keeping all the short premium. This translates to averaging down or scaling into the product. Cost basis reduction.
This is the same as simply being short 2 at the money puts (for every one time you did your play), which may save you a bit of commissions.
I prefer the static Delta from the underlying product so that there is limited risk to the upside. But there are times where the implied vols of the puts are so high that your idea would be much better.
It's worth spending a little time reading about Black Scholes and option pricing. When you understand the huge role volatility has in option pricing and option value all this will make a whole lot more intuitive sense.
I am thinking from the buyer of the calls perspective. If he bought the OTM call for 0.60 dollar Strike 103 when the spotprice was at 100 and 2 days later the price of the stock is at 104 (ITM). Why wouldn't he want to assign now since the option could be worth for example almost 2 dollar now and make a profit. Why would he take the risk to wait until expiration when he could make a profit now on the option? I try to see it from the buyers perspective in this scenario to see if any logic comes out from this.
Again you really need to understand the value of optionality to understand options. Except in certain dividend situations it is always optimal to sell an option rather than exercise it because almost every option has some value above its intrinsic value. This is absolute basic fundamental options 101, until you grasp this you won't understand options.
I think I have a quite good knowing about how the options are price but still learning I know options are "overvalued" if IV is high (historically speaking) which for example can happen before dividends. The value above the intrinsic value is the time value. If the dividend is larger than the timevalue it could be a good idéa to exercise the option. But I am not sure if this knowledge helps to understand why a person don't choose to exercise the option at 104 ITM when having a decent profit. What I don't understand why this person take the risk to wait until expiration. I am not sure I understand the logic of this. For example why shouldn't 50% of all option holders choose to exit at 104 rather than taking the risk and wait until expiration if price goes below 103?
No one is going to be able to explain Black-Scholes to you in a forum post. Check a book out at the library or take a MOOC, both are free. You'll probably want to do the same with a prob stats class while you're at it. What you're asking is essentially like asking an electrical engineer how an integrated circuit works or an aeronautical engineer how a wing works, you need to have some background in the subject before you can understand the explanation.