actions needed after spread expiry

T

ter1717

I am a newbie in option and have been learing all the option basic and strategy ( credit spread , iron condor etc..) . i have started papertrade and has since move to live trading via thinkorswim platform. I have some question regarding action/steps needed after expiry and seeking enlightenment and assistance.

I understand a credit spread is loss limited but need to know what step or action one need to take to ensure the loss is limited after expiry. ( Assuming I did not do any rolling or cut-loss and let the spread expiry ....)

eg: Bull Put Credit spread
short a PUT at $60 and long a put at $50
Max loss will be $10 per option unit of $10X100.

(1)At expiry, stock price at $52, so only the short put is ITM.

What does one need to do to ensure the loss will be as expected at $800 ? ($60-$52 = $800)
ie: as the PUT60 buyer will most likely exercise the option and I will be "assigned", do I need to pick up the stock at $60 (which means I need to have $6000 in acct) and then resell it at the market price $52 so that my loss will be $800 as anticipated ?


(2) At expiry, stock price at $40. so both short and long put are ITM.
Again, my short put $60 will probably be assigned , do I need to exercise my long put$50 so that my total loss will be $60-$50 = $1000 as expected......
Hope this is not too stupid a question but it can be a real life situation when one left the spread go expiry due to some reason and I will appreciate any one that can hlp shed some light to my question ...

Thanks.
Terence
 
Yes, if the option is exercised against you, you get 100 shares for one contract. That means you need enough excess liquidity to hold the shares you are assigned, and this number is much higher than what is needed to hold just the option, due to the higher leverage of options.
 
<<< What does one need to do to ensure the loss will be as expected at $800 ? ($60-$52 = $800)
ie: as the PUT60 buyer will most likely exercise the option and I will be "assigned", do I need to pick up the stock at $60 (which means I need to have $6000 in acct) and then resell it at the market price $52 so that my loss will be $800 as anticipated ? >>>

The only way to guarantee your loss is limited to $800 is to close the trade BEFORE the contract expires.
That being.... depending on how much time value is still in the trade, and whether the stocks IV (implied volatility) affected you negatively.... once your stock is trading between your strikes, check the bid/ask and figure out your cost to close the trade before expiration.
If you want to keep the trade intact, hoping for a recovery, but wanting to limit your loss to $800, check the bid/ask, and close the trade when your loss hits $800.
Your loss may be less then $800, even if the stock is trading at $52, depending on whether it dropped early or late in the contract..... per the affect of time decay on your trade.

If you wait until expiration day and own the stock at $52 after the close on friday, your loss on monday may be greater or less than $800 on monday,.... depending on where the stock trades on monday.
So the only way to be sure what your loss is, is to close a deteriorating trade BEFORE it expires.

Once the stock trades below both your strikes, then your loss would be limited to the difference of your strikes.
In your case $10.
Doesn't matter if the stock is trading at $10, $20, or $30.
Once it trades below both your strikes on exp day, there is nothing for you to do. The trade is over and your loss is $10..... or $1,000 per contract.
 
It makes a very big difference if you are trading European type or American type op ex products... Equity index products such as SPX or RUT or equity products like WMT or APPL.

With cash settled products then you are correct and you can only lose the spread. The problem with American style op ex products you can lose more than the spread. I make it a point to close ALL my non-cash settled spreads. Of course there is often more cost incurred but saving yourself all the headache's associated with perhaps being exercised early on the short side or forced into a bad decision by holding until Friday op ex, is totally worth closing early.

I would start with trading cash settled products if doing spreads. If you have a strong opinion on the stock and don't mind owning it then trading the simple put/call is fine. GL
 
three things:
1. if the spread is $10 your loss maximum is not $10; it is $10 minus your original credit
2. if you do not have enough cash to cover shares to be assigned to your account, your brokerage will generally force liquidate your position probably on the last trading day (expiration day)
3. on the internet there is egregious disinformation that credit spreads are somehow "sure money"--well, in actuality, you really have to know what you are doing, and you can lose a LOT of money trading credit spreads
 
Quote from Put_Master:
Once the stock trades below both your strikes, then your loss would be limited to the difference of your strikes.
In your case $10.
Doesn't matter if the stock is trading at $10, $20, or $30.
Once it trades below both your strikes on exp day, there is nothing for you to do. The trade is over and your loss is $10..... or $1,000 per contract. [/B]
More...


Hi Put Master,

Once the trade is over and stock price below both shot & long put (eg: short put $60, long put $50), are you saying one need not do any thing and TOS will simply minus off the loss $1000 fr my account?

My concern is my short put $50 will be assigned and whether I will need to exercise my long put $50 to ensure limited lost at $1000.

Or as it is a spread, TOS will automatically handle the trade and deduct off $1000 fr my account?

I'm not too concern on the exact amount of loss (eg: should exclude the premium collected etc) but more on the necessary action/step one need to do after the trade is over to achieve the anticipate limited loss ...... and not receiving a shock after my short put was being assigned but I did not exercise my long put etc .....


Rgds,
Ter1717
 
Thanks for all the replies and good advice about closing the trade early before expiry and I do agree.
I'm just trying to make sure I understand all the possible scenario and necessary action need to be taken.

Quoting Putmaster :
""Once it trades below both your strikes on exp day, there is nothing for you to do. The trade is over and your loss is $10..... or $1,000 per contract.""


In the case both short & long put options are In-the-money upon expiry,
Are u saying I do not need to do any thing at all and Brokerage will simply deduct the $1000 (or whatever exact amount) as loss ? This is the point that i'm unsure and seekibg clearification. I'm concern as there is possible assignment (as i hv a short put position that is ITM) , and do I need to execute exercising of the long put position (as im having a long put that is ITM) ?

Or one do not need to bother with the short being assigned and the need to exercise the long to limit his loss when faced with such situation (ie both option in a spread expire ITM) and simply wait for brokerage to deduct the loss amount ?






Thanks.
 
Quote from ter1717:

Hi Put Master,

Once the trade is over and stock price below both shot & long put (eg: short put $60, long put $50), are you saying one need not do any thing and TOS will simply minus off the loss $1000 fr my account?

My concern is my short put $50 will be assigned and whether I will need to exercise my long put $50 to ensure limited lost at $1000.

Or as it is a spread, TOS will automatically handle the trade and deduct off $1000 fr my account?

I'm not too concern on the exact amount of loss (eg: should exclude the premium collected etc) but more on the necessary action/step one need to do after the trade is over to achieve the anticipate limited loss ...... and not receiving a shock after my short put was being assigned but I did not exercise my long put etc .....
Rgds,
Ter1717
More...

Correct.
You keep the credit, unless you used it to initiate more spreads. But your $1,000 is gone and the trade is over.
The only reason to contact your broker, once the stock is below both strikes, is if you still want to buy the stock at your upper strike.

Just a quick word of warning regarding credit spreads.
If you use all your account money to initiate credit spreads, you will be using MASSIVE margin leverage.
Probably in the area of 8 - 10 times your account value... depending on how high your strikes are and how wide your strike gap is.
The higher your strikes, the more leverage you will be using.

It's one thing to use a spread on a particular volatile stock, pre earnings for example.
But to use spreads for all your trades, using all your cash, is a very risky thing to do.
WHY?
Because of the massive margin leverage you will be using, (8 - 10 times your account value), you can NOT buy 90% of your stocks, if they trade below your upper strike.
Thus you must close the trade early, BEFORE it drops below your strikes.
If you are using all your cash for spreads, and they all drop a mere penny or more below both strikes,... your account will be 100% wiped out.... minus any credits received (unless you used the credits to sell even more spreads.)

Credit spreads sound better on paper then they often work out in reality.
On paper, it's a cash transaction, your losses are limited, and you know the limit up front.
In reality, you are using MASSIVE margin leverage, and that loss limit may be your entire account savings.

Bottom line.... if you plan to do a lot of spreads, do the math and figure out how much it would cost you to buy all the stocks, if there were some market event that dropped them.
If it is several times your account value, you MUST close the trades once they drop below your upper strike.... if not before.

Just to give you an idea, of the kind of leverage spread traders can be on,... if you had a $100,000 account, and were using all your cash for spreads, using strikes of $50 or $60, you are probably using close to a MILLION dollars of margin.... depending on your strike gap.
Using spreads on stocks like AAPL and you will be using millions more leverage.

(As a side note.... The more narrow the strike gap, the more leverage you will be on.
So perhaps you think the wider the strike gap the better the trade.
Not if there is a "spike in IV" (implied volatility), as the stock drops.
The more narrow the strike gap, the more the spike in IV is "neutralized".
If you want to close a deteriorating trade that has had a spike in IV, you'll wish it was a more narrow spread, due to the rising of the bid/ask prices. As well as potentially widening the gap between the bid/ask prices.
So there are positives and negatives to both wide and narrow spreads.)

BTW, you will not be charged any fees for the borrowed money while your trade remains a spread. But it is still real margin.
So be sure to add up how much it would cost you to buy all your spreads.... if you plan to do a lot of them.
 
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