Should I care if early exercise/assignment on vertical spread leg?

Discussion in 'Options' started by yosuji198, Sep 12, 2019.

  1. Hi Community,
    I am trading long and short vertical spreads (simple bull and bear spreads). This week I've got all sorts of early exercise. However, I have enough margin in my account to handle the additional shares I've received.

    My question is: if I have enough margin to handle additional shares then can I just completely ignore early exercise? Because early exercise doesn't affect the P&L of a position right? It's only a problem if you don't have enough margin and your broker partially liquidates, which isn't the case here. Is there any benefit to me closing or altering the positions before expiry of the offsetting long options?

  2. FSU


    Generally an early assignment is not a bad thing if you have the capital to cover the stock. The exceptions would be if the assignment occurs just before a dividend (for short calls) and you are forced to pay it out. Also if the stock is hard to borrow and you are assigned on short calls, you would be on the hook for hard to borrow fees. There also may be extra carry costs on a stock position vs your short option position.
  3. If you got exercised on the short side of a bull spread why not just exercise the long option and make maximum value of the spread minus your debit?
  4. FSU


    Because this may not be the right decision. The OP said he has enough capital to hold the assigned stock. So if he is assigned on the short side of call spread, he is now short stock and long calls. This means he is synthetically long a put for free (of the same strike as his long call). He should hold this position unless he needs the margin, or it is costing him money (short stock fees) or if there is an upcoming dividend.
  5. Now he has a completely different position from his bull call spread.

    If he has a $50 - $55 Bull Call Spread for $2.00 and is assigned on the $55 Call he is short stock at $55.
    He is also long a Call at $50. Nothing is for free by the way, he still has his $2.00 debit.

    Please explain to me why he should hold the position if his MAX GAIN is always going to be $5 - $2 = $3.00.

    If stock goes to $1,000,000, his profit is capped at $3.00.

    You telling him to hold it means he has CHANGED his outlook and position from a bull call spread to a long put. The only reason to hold is because you now think the stock will drop in price.

    This is now a new position so to be clear HE NEEDS A COMPLETE CHANGE IN HIS TRADE ANALYSIS. Now you are just guessing because it was a bullish position and he would not be assigned unless the stock was well above $55. So for him to switch to bearish seems against the trade plan in most cases.

    Also, please don't say he now has a LONG PUT for free. really? it is only free if he covers the short stock for a profit and sells the call for more than $2.00 prior to expiration. Otherwise his profit is always deducting $2.00 debit he sunk in. Getting assigned does not erase a debit unless the long call sale can cover it later.
  6. FSU


    Think of it this way. After he is assigned he can exercise his long calls as you suggest and be done with the position. He will have sold the call spread for the maximum amount and have no position. But if he doesn't, he is long calls and short stock. He can still exercise his calls at any time in the future and get that same maximum amount, but if the stock drops he can make even more money. He has no risk of losing anything more, but if the stock drops enough he will make more. No risk just opportunity ( if there are hard to borrow fees or a dividend, this could cost more though). So he doesn't need to change is trade analysis as you suggest, he has gotten max profit and has a free shot on the down side.
  7. ET180


    Most brokers assign an additional fee for exercise or assignment. My broker, IB does not.
  8. newwurldmn


    He will be long a “free” call.

  9. I am not seeing the free aspect here.

    Using hypothetical he buys a $50/$55 Call Spread for $2.00. Stock moves to $59 and he is assigned the $55 Call.

    He is short the stock at $55 with a Call at a $2.00 cost basis


    He is short the stock at $53 - ($55 Short price minus the $2.00 debit) and a $0 cost call if he divides the two positions mentally. At $59 he has a (assuming intrinsic value) $9.00 $50 Strike Call and a short stock with a loss of $6.00. Hmm what does that equal...........

    wait for it....

    $3.00 net gain...

    If stock moves higher in all scenerios he has a $3.00 locked in net gain. Nothing is free I believe.

    Now if stock tanks hard he has a situation where everything changes and he can profit form the short stock and cover the net debit. But this means he is assigned at $59, let's say and suddenly has a radical change in his trade assumption.
  10. Well I understand and agree with what you are saying in theory. But holding on does not make sense when the trading gods hand you an early assignment on a bull spread.

    He got into a bullish position that went in his favor and hit his max profit and you are saying he should change his mind and let it run in case it reverses now in a major way. Theoretically what you are saying is correct but in reality you entered into a bull call spread and the trading Gods gifted you a favor with early assignment on your short leg.

    I think the mentality of I got a profit but let me see if it reverses to make even more money is a dangerous precedent to set for trading, IMHO. Once assigned the max profit is locked in. Often assignment occurs when time value premium is really small. So that means expiration is approaching. Exercise and take the money

    In my opinion if you have a bull call spread and are assigned on the short call because it is ITM, the best and consistent move is to exercise the call and lock in the max gain and move on to the next position.

    In my example, the stock that went from lets say $51 to $59, now has to go back to $49 for you to make additional money. Trade management seems to indicate it would b best to take the locked in max gain as a successful position.
    #10     Sep 12, 2019