How common is assignment?

[trendisyourfriend]

Hi all, I'm new to options trading and just read an article by Gavin McMaster from IBD's Options corner.

He suggests selling a Aug. 6 expiring bull put spread with a 180-strike put and buying the 175 put.

The current stock price of Etsy is 183.51.

The short put is not in the money at the moment but I've read that short options can be assigned at any time, even if they're not ITM. Is this common?

If a person has a $10,000 trading account and they get assigned, they will need to buy $18,000 worth of Etsy stock. They're deficient $8000.

Will they get a margin call? How expensive can margin calls typically be? I've heard of traders losing their entire account from a margin call.

 

[BMK]

I've read that short options can be assigned at any time, even if they're not ITM. Is this common?

It's not common for an option to be exercised/assigned when it is out of the money. If you are close to expiration, e.g., one or two days away, and the option is out of the money by only five or ten cents, then it might happen.

If it is the afternoon of expiration, and the stock is trading right around the strike price, e.g., the strike is 180, and the price of the stock is trading in the range of 179.40 to 180.15, then you must assume you are going to get assigned, even if the clock says 3:58:45 and the last sale was 179.62. Your pricing data could be delayed, even if you are paying for professional market data. And a sale could take place in the last few seconds before the market closes, and that sale could be below 180, and you won't know it until the data is registered and displayed after the close. So you have to assume that the option will be ITM, and you should buy to close it. If the price is that close to the strike, then buying to close it should only cost a few bucks.

Assignment of an option that is totally out of the money can indeed happen, and it can happen at any time, but it is not at all common.

Your question about a margin call is more complicated. Yes, you can certainly get a margin call if you get assigned on a put, if you don't have enough money or equity to buy the shares. But the broker can also choose to immediately sell of the shares at the market price to eliminate any risk.

The real risk is not a margin call, but holding the stock overnight if that is not part of your strategy.

Suppose you are short the 180 put and long the 175 put, as in your example.

At expiration, the stock appears to be closing at 180.51, so you take no action, assuming that both legs of your spread will expire worthless. But the official closing price turns out to be 179.94. You get assigned on the 180 put, and the 175 put that you are long expires worthless.

Even if your account is only worth $4,000, and you cannot really afford to buy $18,000 worth of stock, you cannot assume that your broker will take action to limit your losses. You will buy 100 shares of that stock at 180. You'll get a margin call, and on Monday morning, if you don't deposit money, your broker will probably sell the stock, and may only tell you about it after it happens.

But you'll be long the stock over the weekend with no hedge. Your long put expired Friday afternoon, at the same time that the short put was assigned.

On Monday morning, at least in theory, the stock could open at $80 per share (or even lower) on some reaaaaally bad news. You are then forced to sell the stock at that price, and you just lost $10,000 that you do not have.

BMK

 

[BMK]

To further answer your original question...

If you get an early assignment, i.e., before the day of expiration, in most cases, there is usually not a lot of risk, because your potential loss is still limited by the long put in your example.

If your account doesn't have enough money to hold the stock, then you may be forced to liquidate the position the next day, i.e., by selling stock and selling the long put. Or if the stock has fallen below the strike of the long put, then you can liquidate the position by exercising the long put. But you still won't lose more than the maximum loss of your position. In your example, that maximum loss would be $500 minus the credit you collected when you established the position.

When your position involves a short call, you have pay to attention to ex-divided dates, because that can trigger early exercise in some cases. If that happens, you can end up short the stock overnight, and you have to pay the dividend to the buyer. That can completely ruin the "normal" P&L expectations for a position.

BMK

 

[caroy]

I'd second what @BMK has said. Early assignment on a spread is not that big of a deal provided you know how to execute a covered stock order. Your full risk is still the spread width minus the credit received for the bull put spread. If you are trading a small account and can't handle the margin related to the 100 shares which is pretty common just execute a covered stock order and close the position.

https://support.tastyworks.com/supp...-a-spread-closing-with-a-covered-stock-order-

Above is a link to a video explaining how to do it. If you have a decent broker you can call them before the open and ask them to execute the trade. To get filled you might have to give up a dollar or two above intrinsic value. This takes away all the gap risk mentioned above. I wouldn't keep the sho