Early exercise + dividend capture: Did I miss obvious $?

[JackRab]

I think he meant that that both "sides" had the same delta and theta. Long put, long stock has the same greeks as long same strike call. And long call and short stock has the same greeks as long the same strike put.

Exactly, a delta 70 call means the same put has 30 delta (minus). 40d call = 60d put
So the synthetic stock has a delta of 100 (or 1, however you want to put it).

Except in situations where you should exercise the call or put early, which means that call/put has 100 delta. And the same strike put/call has a delta close to 0, but likely has a little bit left. In that case the synthetic has a delta >100, but isn't a real synthetic, since you'll lose one of the legs on early exercise.

 

[JackRab]

I expected if the dividend is greater than the put of the same strike, the call option would get exercised (and buy the put). But on more than several occasions when I was short the call option, I only got partial assignment, so rather than being flat I ended up having a covered call (plus dividend). This had happened when the strike was close to the money, although the dividend amount was clearly greater than the put premium. Even if I was sure that partial assignments would continue, I don't know how to take advantage of it.

That's a common strategy of market makers, to be short the ITM calls just before dividend, when they should be early exercised. Exercised calls will be assigned pro-rate. So, if there's an open interest of 1000 and you're short 200, when 100 are not exercised (usually because of retail not understanding the concept) you are left with 20 short calls and basically have a profit of the dividend minus the put value.

Years ago, I've seen market makers and hft cross-trade massive amounts of ITM calls with either their own subsidiary or a colleague, just to create a large o.i. and basically have 90%/95%/98% of that o.i. and get the most if there are traders not exercising. Usually on stocks with large dividends and an already high open interest... They where crossing tens of thousands.. sometimes in the 100 thousands. It was getting ridiculous and the exchanges banned it...

We didn't actively trade that way, but nevertheless we had days we made 10, 20k or more just on not being assigned for a few hundred or thousand options...

Ah, the good old days...

 

[Kibitzer]

That's a common strategy of market makers, to be short the ITM calls just before dividend, when they should be early exercised. Exercised calls will be assigned pro-rate. So, if there's an open interest of 1000 and you're short 200, when 100 are not exercised (usually because of retail not understanding the concept) you are left with 20 short calls and basically have a profit of the dividend minus the put value.

Years ago, I've seen market makers and hft cross-trade massive amounts of ITM calls with either their own subsidiary or a colleague, just to create a large o.i. and basically have 90%/95%/98% of that o.i. and get the most if there are traders not exercising. Usually on stocks with large dividends and an already high open interest... They where crossing tens of thousands.. sometimes in the 100 thousands. It was getting ridiculous and the exchanges banned it...

We didn't actively trade that way, but nevertheless we had days we made 10, 20k or more just on not being assigned for a few hundred or thousand options...

Ah, the good old days...

If it's deep ITM, then that's fine. But if it is a close to the money call (which were the ones that I only got partial assignment), then you would need to buy an expensive put protection otherwise you may end up with a risky covered call position. But if you buy a put option and it turns out you were assigned, you would end up owning only the put option you bought, which is something you may not want.

 

[FSU]

That's a common strategy of market makers, to be short the ITM calls just before dividend, when they should be early exercised. Exercised calls will be assigned pro-rate. So, if there's an open interest of 1000 and you're short 200, when 100 are not exercised (usually because of retail not understanding the concept) you are left with 20 short calls and basically have a profit of the dividend minus the put value.

Years ago, I've seen market makers and hft cross-trade massive amounts of ITM calls with either their own subsidiary or a colleague, just to create a large o.i. and basically have 90%/95%/98% of that o.i. and get the most if there are traders not exercising. Usually on stocks with large dividends and an already high open interest... They where crossing tens of thousands.. sometimes in the 100 thousands. It was getting ridiculous and the exchanges banned it...

We didn't actively trade that way, but nevertheless we had days we made 10, 20k or more just on not being assigned for a few hundred or thousand options...

Ah, the good old days...

Yes the good ole days!

The way we would do it is look for a stock that had a high open interest in relatively deep in the money calls and a good dividend. This would happen if the stock had run up recently. So say IBM ran from 60 to 90 and there was high open interest in the 60 and 65 calls. I would buy the 60/65 call spread for 5 1000x. I would then exercise my 1000 60 calls ( you could stop here and you are long stock against the short 65 calls, whatever you weren't assigned on was like selling the 65 put for the dividend). Now if you did just this you would pay interest on the $5 spread until settlement. So I would then sell the same spread I had just bought. I would then have no position in the 65 calls, but would be short the 60 calls.

The exchanges didn't actually ban this trade, they just wanted to make sure it was not "pre arranged" I couldn't say to someone I will buy this spread and then sell the same spread back to you. I could buy it and sell it to someone else.

Your risk here was there was an error in the exercise and it didn't go through properly or the stock goes down substantially before you are able to cover your short puts the next day.

 

[JackRab]

The exchanges didn't actually ban this trade, they just wanted to make sure it was not "pre arranged" .

Yeah true, it wasn't banned as such, but in the week or 2 weeks before dividend, if your short position in a strike got bigger, we'd pay a lot higher exchange fee... can't remember the details. But soon after, there wasn't any large cross trading anymore...

 

[JackRab]

If it's deep ITM, then that's fine. But if it is a close to the money call (which were the ones that I only got partial assignment), then you would need to buy an expensive put protection otherwise you may end up with a risky covered call position. But if you buy a put option and it turns out you were assigned, you would end up owning only the put option you bought, which is something you may not want.

This doesn't make sence... why would you buy a put? You're short the call... so if you get assigned, you're short stocks .. if not, still short delta with the call. Adding a long put is just adding to the short delta position....

Oh wait... I know what you mean... you expect to be assigned fully and you either buy the stocks before close or already owned the stocks in a long stock short call position? Then you would feel the need to buy some puts to protect a possible long delta position from not being assigned fully?

Yeah, I get that... but still if the dividend is large enough it would give you a decent starting profit... And usually stocks tend to go up after ex-div anyways...

 

[Kibitzer]

This doesn't make sence... why would you buy a put? You're short the call... so if you get assigned, you're short stocks .. if not, still short delta with the call. Adding a long put is just adding to the short delta position....

Oh wait... I know what you mean... you expect to be assigned fully and you either buy the stocks before close or already owned the stocks in a long stock short call position? Then you would feel the need to buy some puts to protect a possible long delta position from not being assigned fully?

Yeah, I get that... but still if the dividend is large enough it would give you a decent starting profit... And usually stocks tend to go up after ex-div anyways...

Yes, that's what I meant. I should get fully assigned but I don't for the close to the money calls - it's usually partial assignment. But I don't know how to safely take advantage of it because I don't know what percent of the short calls will be assigned to me.

 

[JackRab]

Yes, that's what I meant. I should get fully assigned but I don't for the close to the money calls - it's usually partial assignment. But I don't know how to safely take advantage of it because I don't know what percent of the short calls will be assigned to me.

Well, you need to quantify the risks... do an assessment.

The risk is that you will be a bit more delta long than you would like.... so, how much can you take? And if you're not assigned, how much is the profit per share (dividend minus put value). Is that amount big enough for you to bear the risk of a small drop... Usually stocks tend to go higher anyway the day after dividend.

Give me an example, what was the exact situation? Which stock, dividend, which call option...

 

[Eliterondrouge]

I think he meant that that both "sides" had the same delta and theta. Long put, long stock has the same greeks as long same strike call. And long call and short stock has the same greeks as long the same strike put.

Got it. My point was that call put parity hold for european style options. American style is something different. JackRab pointed out the fact that delta of a long call/short put may have a value beyond 100%, it's a reality and everyone can price it, knowing that interest rates are low nowadays. As far they will go up, things will be magnified.

The second point is about theta. Theta is related to gamma and interest rate. Saying that call theta and (put + underlying) theta are the same is like saying you can borrow at the same rate as the market. It's a big assumption. Call theta and put theta are 'market thetas'. 'Underlying theta' or 'borrowing rate' is directly related to your broker,.... Once again, just wait for a substantial increase in interest rates and you'll see a big difference between the both sides.

 

[JackRab]

The second point is about theta. Theta is related to gamma and interest rate. Saying that call theta and (put + underlying) theta are the same is like saying you can borrow at the same rate as the market. It's a big assumption. Call theta and put theta are 'market thetas'. 'Underlying theta' or 'borrowing rate' is directly related to your broker,.... Once again, just wait for a substantial increase in interest rates and you'll see a big difference between the both sides.

I don't view the interest part as theta... I know, I should.. but I'd rather break it down. I see the interest part of the option premium as part of the intrinsic value, that way it's all a lot more clear that we use forward pricing in options...