A question about debit spread

[traderwald]

Hi guys,

I have a question about bear put debit spread. If I have a stock purchased at $200 and a bear put spread where long put is purchased for strike price $200 and premium $5 and the short put for strike price $195 sold for $2 making the debit of $3 for the bear put spread.

In this scenario, what happens if the stock price on the last date of validity of the put options is $198 ?

At $198, the long put is ITM. Is it correct to understand that the stock gets sold at $200 with $0 loss due the AUTOMATIC exercise of the put and the short put is OTM and hence worthless making loss to be $3, (the price of the debit)

OR

Do I need to MANUAL exercise the long put to sell the stock at $200 ? (i.e if I do not manually exercise the stock, the bear put spread will get squared off at the price of the $3 debit and the long position on the stock will still be there ? )

Thank you

 

[tommcginnis]

Hi guys,

I have a question about bear put debit spread. If I have a stock purchased at $200 and a bear put spread where long put is purchased for strike price $200 and premium $5 and the short put for strike price $195 sold for $2 making the debit of $3 for the bear put spread.
In this scenario, what happens if the stock price on the last date of validity of the put options is $198 ?
At $198, the long put is ITM. Is it correct to understand that the stock gets sold at $200 with $0 loss due the AUTOMATIC exercise of the put and the short put is OTM and hence worthless making loss to be $3, (the price of the debit)
OR
Do I need to MANUAL exercise the long put to sell the stock at $200 ? (i.e if I do not manually exercise the stock, the bear put spread will get squared off at the price of the $3 debit and the long position on the stock will still be there ? )
Thank you

Nope, but close. Instead, your long put @$200 finishes worth $2 -- not accidentally, the same amount by which it was ITM. Your short at $195 does indeed die at $0.
You could choose to have the put exercised (and exit the stock at a $1 loss {the $3 loss you supposed, minus the $2 gain from the ITM at $200}),
OR,
You could sell the $200 put @ $2, and then sell a $198 call on the stock for "$5", and rinse/repeat.

(Please read these closely, and forgive any trespasses. There was beer involved. What a GREAT night, but WOW is it hot!)

 

[TradingDemystified]

At $198, the long put is ITM. Is it correct to understand that the stock gets sold at $200 with $0 loss due the AUTOMATIC exercise of the put and the short put is OTM and hence worthless making loss to be $3, (the price of the debit)

Yes, even if it's ITM by $0.01 ($199.99 in your example) you would get exercised which, since you have long stock with your puts would mean that you sell your stock at $200 (minus transaction fees).
If you didn't have the long stock with your puts you would automatically be short the stock if your long put expires ITM.

Do I need to MANUAL exercise the long put to sell the stock at $200 ? (i.e if I do not manually exercise the stock, the bear put spread will get squared off at the price of the $3 debit and the long position on the stock will still be there ? )

Not sure what you mean by this but I will only say that if you don't want to sell your stock upon expiration at the long put strike price (that is now ITM) you could sell the long put that you own prior to expiration and keep that premium (making up the difference between your Strike Price and where the stock is trading currently). In your example you would MANUALLY sell your put for $2.