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Early Assignment Risk?
- Thread starter PennySnatch
- Start date
Yup. If you can meet the margin call, early assignment is a good thing.
I'm short better than 50% of the time in less than 8 DTE contacts. I've been assigned 4 times. So, not common...
Also, check with your broker about margin requirements. I once for hit by a fed call when I got stuck in airport security and my short put expired .02 in the money. That was a traumatizing, if profitable, weekend.
If your short option is trading above parity, it's very unlikely that you will be assigned early.
Your long leg protects you at all times so if you are assigned early, you can re-sell the option or close the other legs. Your maximum loss is pre-defined.
Robert Morse
Sponsor
I type too slowly to over explain this, but your statement is not true. If a stock is trading at 80 and I'm long the 65 call with 1 weeks to go, and the put is $0.05 and the dividend is x-div $0.50 tomorrow, the call is a clear exercise if I have enough funds for the margin. All things equal, the next day, the stock will start $0.50 lower. The call will be $0.50 lower. The difference is that when the div is paid, I will get my $0.50 back with the stock, but not the call. If I can be long the stock and short the call, excluding fees, I will make $0.50 - the value of the put.
Bob
I've been away from ET for a good number of years. There were many more option participants back then. You would would have loved it even more.
I wonder where they all went and how come they didn't tell me ??? ;->)
Maybe I am confused or missing an important detail in this logic. To get the div, you need to own the stock a day before ex-date to be allocated a dividend. Since the put will be pricing off the ex-div forward price, I don't understand the arbitrage scheme. You can always find a deep-in-the-money put that would have zero time value, but where does the juice come from is unclear to me.
PS. yeah, I am confused - you are buying the stock plus a put, so you get the div naturally.
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I too type slowly with two fingers so perhaps you can indulge me and return the favor and explain this with actual quotes.
One thing I know for sure is that if there was an easy 45 cents profit in this, everyone would be arbing this with every stock going ex-dividend the next day and that ain't happening. There are no free lunches. So methinks you either misunderstood my reply or you need to over explain it better.
Robert Morse
Sponsor
That I'm not going to do, and yes, there are market makers and hedge funds that do this. I did this. You need good margin rates and ultra low commissions, because you have to do a lot of spreads and you never know what you will get away with. This is the general process.
- Look for a stock with a high dividend that has trended up, so there are a lot of calls that are ITM with an open interest (OI).
- Look at ITM calls with a high OI.
- Look for other calls with a lower open interest, as option transactions tend to cost less.
- Sell the call with the larger OI and buy the stock or another call that are ITM.
The call you are selling needs to meet the criteria I talked about earlier. If you bought another call, in my example, say the 75 call, buy paying 5.00 for the 75/80 call spread, you have to exercise the day before the X-date. This is not riskless as there can be news overnight that can make the stock go down before the next morning. If you get away with any short calls, you end up with a buy-write that is ITM. The next morning you can buy that put if you don't want the risk. This is not a retail strategy. The traders that do this count on those with Reg-T not to exercise so they can make money. We used to do thousands of vertical call spreads to have the best chance, if there is OI the next day, of making money. We would add fees in to see if there is enough estimated profit to do this trade.
To the retail trader, what is important is that holding that call into X-Div, can cost you the value of the div. It might be worth looking at your options before that day to have a plan.
Now I need a nap.
Because there are no free lunches, the DITM call will be trading at or close to intrinsic based on the expected early ex even though the put would have some optionality left. No arb, nothing to see there.
If the put is pricing properly off the ex-div forward price, there will be no arb available. Yes, you can always find a deep-in-the-money put that would have zero time value, but does that occur just before ex-div? Or is the dividend priced in? Here's an example of a mispricing:
XYZ is $40
Nov $45 put is $5.30
Dividend is is 50 cts.
Buy stock/buy put, exercise the next day after ex-div
- $40.00 - $5.30 + $45.00 + $.50 = + 20 cents
Here are some not so likely optimistic examples (g) :
INVESTOPEDIA: "For example, suppose that stock XXX is trading at $50 and is paying a $2 dividend in one week's time. A put option with expiry three weeks from now and a strike price of $60 is selling for $11. A trader wishing to structure a dividend arbitrage can purchase one contract for $1,100 and 100 shares for $5,000, for a total cost of $6,100. In one week's time, the trader will collect the $200 in dividends and the put option to sell the stock for $6,000. The total earned from the dividend and stock sale is $6,200, for a profit of $100."
THEOPTIONSGUIDE: XYZ stock is trading at $90 and is paying $2 in dividend tomorrow. A put with a striking price of $100 is selling for $11. The options trader can enter a riskless dividend arbitrage by purchasing both the stock for $9,000 and the put for $1,100 for a total of $10,100. On ex-dividend, he collects $200 in the form of dividends and exercises his put to sell his stock for $10,000, bringing in a total of $10,200. Since his initial investment is only $10,100, he earns $100 in zero risk profits."