Option question.

Discussion in 'Options' started by oraclewizard77, Nov 10, 2010.

  1. oraclewizard77

    oraclewizard77 Moderator

    My understanding is if I bought a stock say 100 shares of JPM and sold a DEC covered call, for IB I would not have to anything if the stock goes above the call price since the stock would be called away.

    However, lets instead say I bought an in the money Jan JPM call and sold an out of the money DEC JPM call.

    Lets assume same situation, in that at DEC expiration the stock is higher than the call price I sold for the out of the money call.

    Will IB automatically sell my Jan in the money call, or do I need to manually close the position, and also close the DEC out of the money call position?

    Also, is there a name for this type of trade?
     
  2. MTE

    MTE

    No, your broker will not automatically close out your long Jan call. If the Dec call expires ITM then you end up with a short stock position, which has its own margin requirement and if your account cannot support it then you would be issued a margin call (although in the case of IB, you are more likely to get automatically liquidated on anything and everything until the position is gone or the margin is covered).

    If you want to avoid assignment then you should buy back the Dec call.

    This trade is called a diagonal spread.
     
  3. As MTE mentioned, it's a diagonal spread. And again, they would not liquidate the long Jan call unless the short stock assignment resulted in a margin violation. Then all bets are off because you either satisfy the margin call or they indiscriminately sell off holdings until the margin deficiency is satisfied. In some cases, your acc't may get restricted.

    If your ITM Jan call had any time premium left, you would not want IB to automatically sell it because you might be throwing money away.

    For ex, you're long the Jan 45c and short the Dec 50c. At Dec. exp the stock is 52. Jan 45c is 7.75 (75 cts time premium), your Dec 50c is assigned and you are now short stock at 50. Why pay 52.75 (45 + 7.75) for long stock to cover when you can buy the stock for 52? Sell the Jan 45c.

    If you haven't been assigned on the short Dec 50c, then place a diagonal spread order and work the order to close both sides (assuming the underlying isn't moving against you).
     
  4. oraclewizard77

    oraclewizard77 Moderator

    Thanks. My thought would be say close to expiration assuming the stock price is above the DEC call, to close both positions. If expiration comes and stock is below DEC call price, the thought would be then to write an out of the money Jan call.

     
  5. There's absolutely nothing wrong with writing an OTM Jan call at Dec expiration as long as you're still neutral to bullish at that time.

    Since JPM has a moderate IV, a 1 month OTM calls won't bring in a lot of premium. Most of your reward will come from price increase to the OTM strike. For that reason, don't write the OTM Jan call just to chase premium (and ignore direction) because with 5 pts of intrinsic value, you can still lose nicely on the long call.