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Cost of Carry > thn corresponding call
- Thread starter Vozdovac
- Start date
Quote from Vozdovac:
Can someone explain in a clear way when you can logically expect to get assigned on a short put?
An example or two showing when the cost of carry is greater thn the corresponding call price would be great.
Why is it "a gift" to me if I get assigned too "early"
Thanks
If I own 100 shares of stock and one put option (equivalent to a long call position), once the put moves into the money, my ony real hope for a profit is for the stock to rally above the put's strike price.
When the put moves far enough into the money, I may give up and decide that the profit potential is near zero (but it's never zero until the put expires).
If I sell my stock and sell my put, I will lose all upside potential, but instead, I save real cash. How much? The amount of interest I would have to pay by holding the put until it expires, and then exercising. By exercising now, I get to earn that interest.
Quandary: Do I want to exchange my position (which is equivalent to a call option) for that small amount of cash. If 'yes' then there is a good chance that put shorts will be assigned an exercise notice.
If the amount of interest is 6 cents per share, I know that I am selling that call equivalent for 6 cents. Any time I can buy the 'real' call option for less than that, it pays for me to exercise the put and buy the call. But, I don't have to do it today. I can hope the call is a bit cheaper tomorrow or the next day.
Sometimes people exercise a put too early. When that happens the assignee gets the 'free call'. If you can sell the call option, converting the long stock to a covered call (equivalent to the short put, on which you were assigned) for MORE than the cost to carry, you have a profit. That's a gift. Or you can hold the call, hoping to earn more at a later date.
Mark
http://blog.mdwoptions.com/options_for_rookies/
Quote from Vozdovac:
Why is it "a gift" to me if I get assigned too "early"
Thanks
If you sell an option short, it's the same as selling an insurance policy. If you get assigned early, then essentially the person you've sold the insurance policy to is telling you "I'm cancelling that insurance policy you sold me before it expires. Don't bother to pay me back the unused portion."
Here's a concrete example. SPY is at 800. You sell a 700 put. SPY goes down to 600. That 700 put is now DITM, is exercised early, and you are assigned.
Now you're long 100 SPY @ 700 and the put buyer is short 100 SPY @ 700. He has a profit, you have a loss.
But imagine that before that put would have expired, SPY goes back up to 800. You've now made 100 points plus the cost of the put you sold, and the buyer has lost 100 points plus the cost of the put.
Had that put NOT been exercised early, you would have made only the cost of the put, and the buyer would have lost only the cost of the put.
Of course there are many possible permutations of how this could play out but the essential element is that when an option is exercised, the exerciser is giving up potential profit and the seller is relieved of potential loss.