Newbie spreads question - profitable entry?

[demoship]

OH, the other problem w/ being assigned early, is you may miss a dividend.

Example:

Stock is at 100, you do your 100/105 spread (long 100, short 105).

Stock shoots up to 200, you think, great, gaurenteed $5 on expiration day.

Tommorow there's a $2 dividend, the 105 call gets assigned to you, you're now long 1 contract of a 100 call, and short 100 shares of stock with a cost basis of 105.

But now, you're paying the $2 dividend, which means you're now $200 in the hole already, when you exercise your calls to sell at 100, you now only get a net of $300 back, instead of the $500 you were seeking (and should've received if you did the right thing and exercised your long calls).

Of course, this is an extreme example, but it doesn't take a stock to double before calls will be exercised to pick up a divvie.

 

[El OchoCinco]

I am not sure you have that correct. A stock will go x-dividend so someone will exercise to be the owner of record on the record date. The dividend is paid at a future date and if you are not holding the short you are not responsible for the dividend.

So if the short is assigned, you still exercise the long and get out with $5.00 cause the dividend has not been paid yet.

I believe this is correct with respect to the dividend so the early exercise is not an issue if you simply cover the short after being assigned.

If someone knows differently I would appreciate an explanation but the dividend is first set on the record date and that is when calls can be assigned early, the payout is some other date in the future (a day or two or a few weeks) and you can cover well before then.

Quote from demoship:

OH, the other problem w/ being assigned early, is you may miss a dividend.

Example:

Stock is at 100, you do your 100/105 spread (long 100, short 105).

Stock shoots up to 200, you think, great, gaurenteed $5 on expiration day.

Tommorow there's a $2 dividend, the 105 call gets assigned to you, you're now long 1 contract of a 100 call, and short 100 shares of stock with a cost basis of 105.

But now, you're paying the $2 dividend, which means you're now $200 in the hole already, when you exercise your calls to sell at 100, you now only get a net of $300 back, instead of the $500 you were seeking (and should've received if you did the right thing and exercised your long calls).

Of course, this is an extreme example, but it doesn't take a stock to double before calls will be exercised to pick up a divvie.

 

[MTE]

Quote from optioncoach:

I am not sure you have that correct. A stock will go x-dividend so someone will exercise to be the owner of record on the record date. The dividend is paid at a future date and if you are not holding the short you are not responsible for the dividend.

So if the short is assigned, you still exercise the long and get out with $5.00 cause the dividend has not been paid yet.

I believe this is correct with respect to the dividend so the early exercise is not an issue if you simply cover the short after being assigned.

If someone knows differently I would appreciate an explanation but the dividend is first set on the record date and that is when calls can be assigned early, the payout is some other date in the future (a day or two or a few weeks) and you can cover well before then.

Coach,
Ex-dividend date is the only significant one when it comes to early exercise of calls. If you're assigned on the day before ex-div, and naturally you will only find out about it on ex-div date, then you're responsible for the dividend, cause you were short stock into ex-div. Even if you exercise the long call on ex-dividend date it is already too late cause it takes 3 days to settle the stock trades and thus you'll miss the record date. Hence you will have to pay the dividend as the owner of the stock you borrowed to short was not on the book on the record date due to you being short into ex-div.

 

[El OchoCinco]

That sounds right, sorry for the confusion and my apologies to the poster.

However with ex-dividend dates being known it is a risk quite easy to avoid. With a stock ITM in this scenario you would simply sell the spread to avoid early assignment. As an index spreader I never worried about being responsible for the dividend lol...

 

[thegazelle]

SPY and DIA can come back to bite you in regards to dividends..

 

[El OchoCinco]

those are ETFs.... i meant the actual indexes, SPX and NDX

 

[thegazelle]

I like the liquidity in the ETFs. Thats not to say there is no liquidity in indicies (you know this of course), but everytime I decide to put on an SPX spread, I just get a headache