Spreads and Early Assignment

Discussion in 'Options' started by andiamo, Jul 22, 2005.

  1. andiamo


    How does early assignment effect your spread positions? From my perspective (that of a newbie), it seems that if you put a spread on and your get assigned on the short leg then you lose that particular profit opportunity. Basically, you would have to start over from scratch. Is this true?

    Specifically, I have been looking at trading some calendar spreads but I don't like the idea of putting on a position only to have the trade interrupted before it has reached its full profit potential.

    When you are evaluating your trade opportunities, do you use the probability of early assignment as part of your selection criteria? Are there any tips for avoiding/minimizing the chances for getting assigned?

  2. Anseld


    not really. if there is no sudden gap the next day, it's actually juicy to get early exercise. all that premium becomes realized. hedge with the underlying until you can start a new leg.

    what could hurt you is if you are forced to short some stock that is expected to pay a dividend.
  3. andiamo


    Okay, but what if I don't want to deal with the underlying stock at all?

    Let's say that I am long a calendar call spread and my short call gets assigned. I could just let them take my long call in the back month, right? But then my spread never gets a chance to reach its full potential.

    This is the type of situation I would like to avoid. Any suggestions on how to do this, if it's possible?
  4. Anseld


    it's pretty simple. then just short that call again.

    there's no rule that says you can't short the same option after it's been early exercised the previous day. your real concern is really the gap move, but not the ability to replace that option leg (unless it's some deep itm call for hard-to-borrow stock situations).
  5. andiamo


    Anseld, thanks for your help, btw!

    But, I'm still a little confused...

    If I get assigned on my short call position, I have two ways to handle the assignment (right?):

    1) Give them stock
    2) Give them a call option

    Let's say I choose method #2 and I give them my long call position from the back month. Now, at this point, my understanding is that I no longer have a spread anymore. I no longer have my long or short position. So, I basically have to put the spread on (both long and short legs) from scratch.

    What is it that I'm missing?
  6. Anseld


    when you get early exercised on the call, you are obligated to sell/short stock at the strike price. since you don't want to hold that short stock, you can just buy it back in the market. this is why you don't want unfavorable gap moves that could make it expensive.

    but no, you can't do #2 unless you exercise and convert your call into stock. the call that you own does not need to be affected.

    what basically happens right after exercise (if you do nothing) is that you end up with a long call and short stock.

    if that's not a position that you want, then just buy back the stock which you were forced to short and then go send your new order to short the exercised option again to reform your original position.

    hope that helps.