let's say i'm short a vertical call spread, and 3 things happen well before expiry: volitility increases, spread goes deep in the money, and my short calls are exercised. is there any way to "repair" this situation and get me back to my max loss at expiry i had before the short calls were exercised?
First you have to be aware that no adjustment can turn a losing position into a winner unless the underlying stock moves as exepcted or you add on risk for a new directional bias. If you are short a call vertical spread, then letting the spread go deep in the money is the first mistake. Forget that for a second and lets discuss the main point you are clearly overlooking. If your short call is assigned, among other things you can do, you can simply exercise the long call to close the position and lose no more than the max risk. This works best when BOTH calls are now itm and you are assigned on your short calls and can no longer cover the vertical. Now if your short call is assigned and your long call is still OTM, then buy the stock to cover to close out the short assigned stock position at the loss that exists and do it quickly to ensure no gaps as best as you can. Then you can sell the long call and get out of all of it. The are other ideas but basically these are your basic steps to take to close out a position where the short call is assigned unless you want to hold the short stock with the long call as a hedge. But bottom line, you cannot repair the position you can only take the loss now and get out or adjust your assumptions about where the stock will go. You can certainly add more option layers but you could be adding more risk or complexity to a position that already was let to go way to far to begin with.
totally agree. basically, i'm looking at these spreads with the idea that i am fine with max loss at expiry, but i've noticed that sometimes volitility will move against me, putting the spread at a loss greater than my max loss at expiry. that's fine as well, since as time passes, the spread increases in value to reach my max loss. the only trouble i see in this approach is when volitility moves against me, putting my spread at a loss which is greater than my max loss at expiry. i'm stuck with a big loss unless i wait till expiry. now, my spread is sunk, and the underlying starts to move against me. i could buy back the spread and get out, but my loss will be greater than my max loss at expiry, not something i wanted or accounted for. so volitility put my spread at a loss greater than my max loss at expiry, and then my short leg goes ITM, and my short leg is exercised. so, if my long call is ITM and my short call is exercised, i can get out at my max loss @ expiry using the methods you described? but if my long call is OTM, i'm stuck with the current loss (which could be greater than max loss @ expiry), unless i assume more risk AND come up with a directional strategy (which i do not want to do)? thanks for helping me understand this, i appreciate it!
Your maximum loss occurs when your short leg is assigned and your long leg is exercised. That means the worst you can possibly do is exercise your call once you get assigned. You can do better, if your long call is OTM, by selling the call to close and buying shares to cover the short from the assignment.
so it's safe to say i can never lose more than my max loss at expiry with a vertical due to early exercise of my short leg?