Broken Legged Option Strategy Trading

[Eliot Hosewater]

ThinkOrSwim lets you paper trade. I think the initial time is 10 days or two weeks, but I've heard they will give you more time if you ask. I would suggest you paper trade your model before committing real money.

Edit: Also TOS lets you start with $100,000 to paper trade. You can see how fast your model eats into the cash as margin requirements build.

It's a real concern if you are worried about the broker liquidating your account if someone exercises early. I would think the broker's software would be able to detect if you are over the margin limit for all these trades.

I've found the people at TOS are readily accessible. You might want to email them or try to set up a telephone call to discuss what you want to do.

Not sure about other option brokers, my only experience is with TOS. Their commissions are kind of high.

 

[spreadgod]

none of your models should include playing with whether or not you will be getting liquidated by your brokerage firm for an early assignment...for 2 reasons.

1. you need to have a plan for your trade, with both a profit and loss target. by trying to keep the assignment you are changing your plan for the trade.

2. by waiting to see what the brokerage firm is going to do, you are no longer in control of your trade. they can liquidate you at any time, and they are not concerned with your profit/loss.

either way, for a debit spread, if you get assigned early you should sell the long option or go with your second choice and close the assignment and short the option again.

for a stock trading at $50 for example, a put spread you may be long the 50 and short the 45. if you're assigned on the 45, you just bought stock at $45 and can sell it at $50 with your long option. but you will most likely be able to sell your long option for more than its intrinsic value on the open market. as the stock drops the option loses more of it's value above intrinsic as it goes more in the money (delta/theta factor etc.) AND the stock you are long is going down in tandem with how much your option is going up in intrinsic value.

a call spread, say long the 50 and short the 55, on assignment you are short stock at 55 but can buy to cover at 50 with your long option. same thing, if the stock goes up, the long option is going more in the money and is almost the exact same price as it's intrinsic value. meanwhile, your short stock is going against you by the same amount of your option's intrinsic value.

getting assigned early would be a gift in my eyes because it allows you to get your max profit, plus some because you weren't counting on getting more for long option. or the extra premium for selling another short contract if you go with that option.

either way, don't go with your 3rd option of waiting for liquidation.

hope this helps.

 

[white17]

Some good advice here Mydann.

I have been trading options daily since 1990 and have never encountered an early assignment. Where did you come up with the number 27% of contracts are assigned/exercised early. I'd be very surprised if that is correct.

 

[mydann]

To White17, sorry for the typo. It's 17%, not 27%. It is quoted from 888options as from CBOE (see my comment above). It is a good news to hear someone from real world about the low chance of early exercise. In my opinion, you didn't get any early assignment as a daily trader is because you are a daily trader and don't keep the options with deep ITM. As a non-daily trader and strategy model trader, I can't be able to monitor my account daily and my be invovled in deep ITM options with negative extrinsic value which would be easier to get early exercise by arbitrageur if someone sells it on open option market. You might be able to close the position easily as a daily trader. But it is hard for me and my strategy model does not allow it.

To Spreadgod, your analysis matches exactly what I am thinking. Thanks for your input because I was worrying about if there is any miscalculation in my analysis. Yes, the early exercise is a gift if it has premium and I handle it myself or have enough margin. It may be a problem if it does not have premium and I don't have enough margin.

After earlier assignment, if my long option goes deeper ITM, my position does not change or closes. But if my long option goes shallower ITM, my position becomes better because of the extrinsic value of the long. And if my long position goes OTM, oh boy, I becomes the BIG WINNER and big thanks to the early exerciser.

I am going to use a strategy model to trade the options. The strategy model is more complicated than a single spread as in my above sample. I have to buy and sell a lot of times with several different kinds of spreads. I can't quit a spread when it is exercised becuase it hurts the other spreads as well. I haven't had a chance to look how bad it is if I close a spread in the moddle because of an early assignment. To me the solution would be (from best to worst):
1> Rebuild the spread if the short option has premium. It is unlikly to happen in real world. Everyone is too smart to do so.
2> Keep the assignment with more than enough margin when the short option does not have premium. I may get extra from the long extrinsic. It can't be rebuild because there are too many arbitrageurs there. Cons: Never screwed up with margin or you are screwed.
3> Close the spread. I should give a suggestion to brokers to bring it as a feature when a spread is created. The choice 1 is another good feature for a spread too. Trader will love it. Will you? Cons: You have to be quick than your borker.
4> Close the assignment. It is most brokers' action if there is no enough margin. This leaves the ITM long option at risk. You may gain more if the long goes deeper ITM and you may lose money if the long goes shallower ITM.

Most brokers require 30% of the stock values if early assignment happens while most option price is only a fraction of the stock price. The choice for me might be only 1> and 3>.

Is there anyone trading options with a model? I don't think I am the first one to do so on this board.

Happy reading. I am going to find where I can get more margin.