Lets say hypothetically speaking that I have an account value of $500. I initiate ONE 100/105 bear call spread on XYZ for a net credit of say $3. XYZ 100 call= $5, XYZ 105 call= $2. If at expiration XYZ is at 105 will I be required to buy 100 shares of XYZ at $105 thus being long 100 shares of XYZ requiring $10,500 (margin call) OR just pay the difference ($500)? Will the account value support this trade? Besides unlimited risk to the upside, what if I just sold the XYZ 100 call naked with the same outcome? Will margin requirments prevent this trade? I now find myself confused with this.
you sold the 100, and purchased the 105 you may get exercised the 100`s, then it would be up to you if you decide to exercise the 105`s you can close the position, then you`d pay the difference. But I believe you`re at risk at expiration, since you normally won`t know if you`ve been assigned until the monday, in which case you`d no longer be able to exercise your 105 you`ll most likely have the position closed where you`ll pay the difference. If you`re assigned from your 100, then you`ll have to buy the shares at the market price, and deliver them at 100, so you`ll lose the difference. Remember, call is option to buy. You`ve sold someone the option to buy your shares, (which you may not have ), so if you`re assigned you have to get them, then sell them for cheaper than their worth (at the strike). you could go naked, if your broker allows. but if XYZ goes to 115, you`ll have to buy at 115, then deliver then at 100. Whereas, if you cap your risk at 105, you can exercise your 105, then deliver at 100, limiting your risk. hope that helps.
1) If the stock finishes above 100, you know you will be assigned an exercise notice and be forced to sell stock at $100 per share. 2) If the stock finishes at 105, and if you still have the bear spread, then you will NOT be <i>forced</i> to exercise your call. BUT you WANT to exercise. If you fail to exercise, you would be naked short 100 shares of stock and with a tiny account, you cannot meet the margin requirement. On Monday morning (following expiration), your broker will force you to cover the short stock. The price may be either higher or lower than 105, but it would be very foolish of you to gamble. If you exercise the call, you pay $105 for the stock. That means you paid the equivalent of $500 for the spread, losing $200. If he stock finishes at 105.00, you MUST notify your broker - immediately after Friday's close - that do want to exercise your 105 call option. If the stock ends at 105.01 or higher, the option will be automatically exercised for you - but to be safe, it's a good idea to tell the broker you do want to exercise. When you list as an alternative 'just pay the difference' the question is to whom do you pay it? There's no one to provide that service for you. You MUST enter an (limit) order to buy the spread, but please never pay as much as $5.00. Try to pay less. Mark
So will the broker just instantly cover the short position at market price? If XYZ is trading below 105 won't I see that? Why do I exercise the 105 call and lose more on the spread rather than let it expire worthless? Maybe that is where I am not understanding when you say gamble. I don't get the sequence of events that take place on Monday following expiration.
On monday morning the options that you bought will have already expired worthless on Saturday, so you cant wait til monday to decide whether to exercise.
BTW, on a related note, I have a tradeking IRA account which allows me to sell spreads I sold one spread for AZO 155 to 160. since it was 159 hovering and since I am not supposed to hold naked short shares in my IRA( as i cannot contribute to it) unilaterally at 3.59pm, I saw that Trade king did close the spread with the market price. which was 4.8 range.
You are making this more complicated than it is. 1) You have $500 in your account. You cannot be short 100 shares of a $100 stock. 2) Your broker will do one of two things - and it depends on who your broker is. You will have to call EARLY Monday and ask what they are going to do. Choice 1: They will enter a market order and buy the stock at whatever price they have to pay. They will not care about getting you a decent price. Choice 2: They will issue a margin call, requiring you to deposit sufficient cash immediately. They may give you a day or two, but an account as small as $500 is probably not qualified to be a margin account. Expect that they will choose choice 1. If you can get permission to trade pre-market on Monday morning, you may be allowed to try to buy the stock yourself. But if the position is not covered by the time the opening bell rings, my guess is that the broker will just buy 100 shares for you. 3) If the stock is trading below 105, yes you will see that. You ask: Why do you exercise the call? You don't. You cannot. As has already been explained to you, the option no longer exists on Monday. Your last chance to exercise was Friday, shortly after the market closed for trading. 4) On Monday, you want to know the sequence of events? You look at your account and see what your position is. That's all that happens. If you failed to exercise your long call, you are short 100 shares. It's too late to do anything, and the shares must be covered immediately (in your circumstances. Other investors, with larger accounts, have the right to remain short those shares) 5) When I say gamble, I mean this: You could have intelligently exercised your call last Friday. That would have given you no residual position. You would have lost $200 and that's that. You are now short 100 shares. That's a big gamble because if the stock opens above 105, then you are going to lose more than $200. It may even be as much as $1,000 if you are unlucky. But, if the stock opens lower than 105, you will lose less than $200. If you get lucky and the stock opens at 101, you wind up earning $200. That's the definition of gambling. You closed your eyes, spun the wheel, and where it stops... Mark
No notice? No warning? $4.80 was a horrible price when spread was worth only $4 Why didn't you cover yourself???? Mark
Ok I appreciate the insight it makes a lot more sense now. If I get assigned to sell the short call any time before 3:59 EST on expiration Friday the short position would automatically be bought back by the broker for market price (unless the account has sufficient funds to hold that position) correct? The gamble is in not exercising the long call while the short call may be assigned either at or after hours thus holding a short position over the weekend and not being able to do anything about it. Sorry sometimes it takes a while for something to sink in, but I will not forget it. Thanks again.