Recently I've decided to understand derivatives and options trading. With my research I've also opened a demo account with Optionshouse to test out a trading platform and have some experience placing trades. I'm going to be depositing a small amount (<$5000) in the account to test strategies. My question is this: - Assume my cash account has $5000 dollars in it. The demo account allows me to create vertical spreads where I would not have enough cash in my account to afford assignment, seemingly because the written option offsets the cost. For example, I can buy 10 contracts that cost more than $5k total, but it lets me buy them since I am also selling 10 contracts. What happens if I am assigned on those ten that I sold?
I assume these are Debit Spreads and not credit spreads you are interested in. If so I would trade $500.00 - or less - and only buy options, do not buy credit spreads. The short leg will cause you nothing but problems if you pick the right direction. If you want to lower the cost/risk of the trade consider buying one strike further OTM.
My understanding is you need enough cash as if you were buying the shares outright (either long call or short put). And then you sell it after. So while you could do vertical spreads with little money, you would have trouble at assignment period if you don't actually have enough cash to buy the underlying shares outright and then sell it again for the other leg of the options. e.g. Vertical call spread on AAPL, long 595 strike, sell 605 strike a few weeks out may cost only around $400 to put on. So with $5K you can put on quite a few. But, each 100 shares of AAPL is actually around 60K so clearly $5K account can't handle even 1 contract come assignment, and not even with margining of the $5k cash equity.
Okay, thanks! I did mean a debit spread, and I'll take your advice. I was attracted to the vertical spreads because of the fixed risk/reward and easily calculated ratio. It seems like you're saying to never write options? You completely understand my question. Optionshouse still allows me to place the trade anyway, even though there is no way the $5k account could actually buy or borrow 100 shares. Weird.
$443.00 to be exact. And the short call will be like having a piano tied to your back. The AAPL 600 call is $4.25 ($425.00) and there is no short call to cap profits.
Talk to your broker about how the assignment works there. Often times they let you put it on because the risk is capped, and the margin used is often (depending on the broker I guess) no more than the theoretical max loss. But sometimes an account can't actually service the assignments. In that case maybe one has to close the contracts themselves at or near expiration. The problem then comes the illiquidity and the mile wide bid/ask spreads at or near expiration that can turn a profitable trade to even a losing trade. I myself normally leave some margin room. But I havent been a huge fan of spreads recently (unless IV is really high). If I have a directional position to bet on, I'd probably just be long an option instead of spreading it and ramping up the no. of contracts with the same cash cost. The problem with spreading it, is you are stuck in a position sometimes. Say a call spread, if stock goes up, your long calls make money but your short calls lose money. So you're stuck. You can't close it out with much if any profit even if long calls are ITM already or deep ITM.
Exactly. I'm not a huge fan of spreads for that reason. but sometimes you need to do it. If the IV is really high for those momo names, it wouldn't be too wise to just buy options outright.
Doesn't matter if IV is high or low. If the short option ends up ITM then you will probably be buying it back for more than the premium you received. If you want to lower the risk move the long position up one strike, and forget about the short position.
Do you even trade options? Thats just not true at all. You can goto assignment. Thats how you close out of a spread position and profit on the equities trades. All the options will close out at exactly $0 at expiration after assignment. This is also the topic of the thread as the OP has already told you. And you sometimes actually do want to spread it for high IV options rather than buying outright. And buying a few strikes up just because it costs less could mean you lose all your money if the stock stays flat or under the strike. All of this is pretty options 101 stuff. I have a feeling you don't trade options.