Early assignment question

[dagnyt]

Quote from piezoe:

Mark, I'm afraid that figuring out what it is you are trying to say is is beyond my intellectual powers. Your main point was, i think, that being assigned early is nothing to fear, and on that point we are in agreement.

I re-read my original blog post, and apologize for not being clear.

If you are short a call - let's say it's part of a bearish call spread, in which you are currently losing money.

Assume:

a) You sold the 60 call and bought the 65 call. You have a bear spread

b) The stock rallies all the way to $75.

c) You are assigned an exercise notice on the 60 call. Your position is now long the 65 call and short stock.

d) If the stock suddenly declines to 52, you reap a very nice bonus. You get to buy the stock at 52. Because you sold it @ $60 when assigned, you have an extra profit of $800.

If you were not assigned and still owned the call spread, the options would become worthless and you would keep, as profit, the premium you collected earlier.

But now, you have a gift. An extra $800.

e) Sure this is not likely to occur, but when assigned early on a call option, you get the equivalent of a free put option at the strike. Your free $60 put became a big winner in this example.

I hope this helps.

Mark

 

[piezoe]

Yes, it does help. Thanks.

Quote from dagnyt:

I re-read my original blog post, and apologize for not being clear.

If you are short a call - let's say it's part of a bearish call spread, in which you are currently losing money.

Assume:

a) You sold the 60 call and bought the 65 call. You have a bear spread

b) The stock rallies all the way to $75.

c) You are assigned an exercise notice on the 60 call. Your position is now long the 65 call and short stock.

d) If the stock suddenly declines to 52, you reap a very nice bonus. You get to buy the stock at 52. Because you sold it @ $60 when assigned, you have an extra profit of $800.

If you were not assigned and still owned the call spread, the options would become worthless and you would keep, as profit, the premium you collected earlier.

But now, you have a gift. An extra $800.

e) Sure this is not likely to occur, but when assigned early on a call option, you get the equivalent of a free put option at the strike. Your free $60 put became a big winner in this example.

I hope this helps.

Mark

 

[riskfreetrading]

Quote from nravo:

Let' say I am doing a dividend capture and using a short deep ITM call, two-to-three months out, to hedge my long stock for 61 days (to get the favorable tax treatment on the dividend.) What is the likelihood and reason why my deep ITM call would be assigned early. Could it be bought back in pre-market trading for some reason, perhaps by a market-maker, and leave me unhedged, and probably unprofitable on this trade? I use IB, btw, if that matters.

Here is how to think about it:

1. Assignment of an ITM call is equivalent to turning your short ITM call to a long put at the same strike.

2. Wise guys do it when the assignment costs the holder of short call more than the price of a long put. They will further do the latest they can so that they do not carry the risk of stock. Therefore they hit on the eve of ex-dividend.

3. Using 1. and 2., you will get assigned if the dividend is greater than the price of the put at the strike of your short ITM call.

So on the eve of ex-dividend compare put price to dividend. If lower, they will hit you overnight.

Some people say that assignment leads to a free put. In fact, it leads to the most expensive put as explained above, because the wise guys will have you pay a higher price for the same put bought in market at a price less than the dividend. They capture the difference between dividend and price of short put, which is expensive and definitely the opposite of free.