Selling Deep ITM Calls vs. Shorting Stock

Discussion in 'Options' started by Finchy, Jul 18, 2011.

  1. Finchy


    Besides limiting one's upside, is there any other risk to selling deep ITM calls versus outright shorting of a stock? (Assuming the stock pays no dividends)

    There is a hard-to-borrow stock I want to short, so I was thinking to sell some deep ITM calls a few months out instead. I think it will slowly drift down, so I could roll the calls over as expiration approaches if I want to stay short. I know that the tiny amount of premium I sell will not make up for what I lose (or rather wont gain) in the event that the stock makes a steep drop below the option strike, but it seems like a viable way to get short exposure if I cant find a borrow. What am I missing?


  2. KPS21


    It depends somewhat on why you can't borrow stock. Nobody can get stock? Or you personally are not in a great position to borrow stock, because your broker is not great with locates/rates?

    The calls you are looking to sell will already be cheaper than they would be under normal put/call parity. By checking P/C parity, you can reverse engineer the borrow costs that market makers are using - which, of course, is a reflection of their cost for holding short stock.

    Your available rates may be worse than theirs, which might indicate that selling the calls is better than paying your broker through the nose to get a locate.

    However, the major drawback is the transaction cost. Deep calls have wide bid/ask spreads. I'd be nervous to start out with a plan for rolling into those spreads over and over again.

    Note that you risk getting assigned on the call. But had you been short the stock, you would have the risk of being bought in anyway.
  3. spindr0


    Deep ITM calls usually have wide spreads and little to no time premium unless you go way out timewise and then you have other issues.

    If they trade below parity you may be assigned early and with no available stock to borrow, you'll have to buy in and resell something else (more slippage and commish). The price at which this occurs may incur a realized loss but that's not a problem if in the long run, your UL collapses.
  4. FSU


    As said earlier, your risk is being assigned on your calls. You may want to look as buying a deep put, or doing a combo where you buy the put and sell the corresponding call. You will pay a premium here representing the "hard to borrow" premium, but will not have the same risk of assignment.