Early assignment

[MTE]

Quote from daddy'sboy:

Hi MTE
Sounds a bit complex to calculate. Why not just work out the short call's extrinsic value and if it's equal to or less than the dividend, early exercise is virtually guaranteed? The maths seems a little easier than "corresponding put, cost of carry ..."?
No?
Best
daddy's boy

Actually, no, the extrinsic value of a call consists of time value and cost of carry, which includes the dividend, so comparing it to the dividend doesn't make sense.

When you evaluate whether to exercise the call early or not the idea is that you assess whether the revenue (dividend) is enough to cover the cost of the synthetic position (put premium plus the cost of carry on the stock) or not.

 

[daddy'sboy]

Quote from MTE:

Actually, no, the extrinsic value of a call consists of time value and cost of carry, which includes the dividend, so comparing it to the dividend doesn't make sense.

When you evaluate whether to exercise the call early or not the idea is that you assess whether the revenue (dividend) is enough to cover the cost of the synthetic position (put premium plus the cost of carry on the stock) or not.

Thanks MTE. Is it easy to calculate the cost of carry, if so, how is it done?
daddy's boy

 

[MTE]

Quote from daddy'sboy:

Thanks MTE. Is it easy to calculate the cost of carry, if so, how is it done?
daddy's boy

Cost of carry is strike price*interest rate*days to expiry/360.

Mind you that professionals pay much lower rates then retail so using the fed funds rate is a good estimate when calculating the cost of carry.

So, for example, say the strike 65 and there are 11 days to expiry. The cost of carry would be: 65*0,0525*11/360=0,104 or about 10 cents.

 

[Neoxx]

Quote from momoneythansens:



However, what the OP is perhaps not aware of or perhaps wants to avoid is that when you have a debit spread, legging into a box is equivalent to legging out of a credit spread in the manner described above.

2 cents.

MoMoney.

Thanks for that, MoMoney. Hadn't realised I could achieve the equivalent by legging into a box. Does seem a bit more hands on though, i.e. after I've bought back the short, will usually look to set a trailing stop on the long leg. May not get the best exit, but fair chance of at least B/E if I get the first part right.

My market monitoring can be sporadic at times due to work so anything to make it less time intensive is very welcome!

 

[momoneythansens]

Quote from Neoxx:

Does seem a bit more hands on though, i.e. after I've bought back the short, will usually look to set a trailing stop on the long leg.

No problem. To be clear, legging into a box on a debit spread and legging out of the synthetic equivalent credit spread entails buying and selling the exact same options. It's not clear from your comments whether this was understood i.e. it should be no more hands on as far as closing the spread is concerned.

Just in case, a little illustration might be beneficial for any interested:

                 Bear PUT debit spread      Bear CALL credit spread
                 ----------------------------------------------------
Initial Spread   LONG 60P/SHORT 50P         LONG 60C/SHORT 50C

Legging out 1    LONG 50C                   LONG 50C (buying back short strike)
Result           Synthetic LONG 60C         LONG 60C

Legging out 2    SHORT 60C                  SHORT 60C (selling out long leg)
Result           50/60 BOX                  No position

You'll note that the exact same transactions were applied to the debit spread and the credit spread.

FWIW, the box technique can also be used to close a spread, leg by leg without being naked when the underlying moves in your favor and you want to close early on a credit spread etc.

Good luck!

MoMoney

 

[Neoxx]

Thanks again, Mo.

You're right, I think I misunderstood, and box conversions definitely look useful.

I suppose you're essentially choosing between assignment risk and pin risk when choosing between debit vs credit.

On balance, I think I'd prefer the former... although I'm sure it occurs more frequently, it's to some extent within your control. Pin risk on the other hand...

Then again, maybe I'm just been paranoid

 

[stock777]

The graveyards are full of people who said, "What, Me Worry"