Should I care if early exercise/assignment on vertical spread leg?

[FSU]

Well I understand and agree with what you are saying in theory. But holding on does not make sense when the trading gods hand you an early assignment on a bull spread.

He got into a bullish position that went in his favor and hit his max profit and you are saying he should change his mind and let it run in case it reverses now in a major way. Theoretically what you are saying is correct but in reality you entered into a bull call spread and the trading Gods gifted you a favor with early assignment on your short leg.

I think the mentality of I got a profit but let me see if it reverses to make even more money is a dangerous precedent to set for trading, IMHO. Once assigned the max profit is locked in. Often assignment occurs when time value premium is really small. So that means expiration is approaching. Exercise and take the money

In my opinion if you have a bull call spread and are assigned on the short call because it is ITM, the best and consistent move is to exercise the call and lock in the max gain and move on to the next position.

In my example, the stock that went from lets say $51 to $59, now has to go back to $49 for you to make additional money. Trade management seems to indicate it would b best to take the locked in max gain as a successful position.

Think of it as an entirely new position. The call spread is now gone.

If someone said to you, hey El Ocho, I'm going to sell you some calls at parity and let you short the stock at the same price. You won't have to pay commission on this trade. You will receive a short stock rebate on your short stock, which will make the trade profitable no matter where the stock goes. You can't lose money on the up side but you can make even more money on the downside. Would you do this trade?

This is the position you would have after the exercise. The only question is there a short stock rebate or hard to borrow fee or dividend.

 

[newwurldmn]

I am not seeing the free aspect here.


Using hypothetical he buys a $50/$55 Call Spread for $2.00. Stock moves to $59 and he is assigned the $55 Call.

He is short the stock at $55 with a Call at a $2.00 cost basis

OR

He is short the stock at $53 - ($55 Short price minus the $2.00 debit) and a $0 cost call if he divides the two positions mentally. At $59 he has a (assuming intrinsic value) $9.00 $50 Strike Call and a short stock with a loss of $6.00. Hmm what does that equal...........

wait for it....

$3.00 net gain...

If stock moves higher in all scenerios he has a $3.00 locked in net gain. Nothing is free I believe.

Now if stock tanks hard he has a situation where everything changes and he can profit form the short stock and cover the net debit. But this means he is assigned at $59, let's say and suddenly has a radical change in his trade assumption.

Yup. The stock tanking hard is his free option.

If he wasn’t assigned when the stock got to 59, he should be afraid that the stock sells off to below 50 and he will lose his entire premium.

 

[El OchoCinco]

Yup. The stock tanking hard is his free option.

If he wasn’t assigned when the stock got to 59, he should be afraid that the stock sells off to below 50 and he will lose his entire premium.

Yes but the premise is he was assigned. If the feeling that the stock will now tank hard below $50, in this hypothesis it may still be better to close the bull call spread and then open a new bearish position with more time to expiration since the assignment occurred often because (1) time to expiration is short and time value premium is gone or (2) the spread is waaay ITM.

 

[El OchoCinco]

Think of it as an entirely new position. The call spread is now gone.

If someone said to you, hey El Ocho, I'm going to sell you some calls at parity and let you short the stock at the same price. You won't have to pay commission on this trade. You will receive a short stock rebate on your short stock, which will make the trade profitable no matter where the stock goes. You can't lose money on the up side but you can make even more money on the downside. Would you do this trade?

This is the position you would have after the exercise. The only question is there a short stock rebate or hard to borrow fee or dividend.

I would close the spread and open a new bearish trade if you truly thought it would tank. If you are assigned it often means one of two things:

(1) time to expiration is close and time value premium is nil - so you are almost out of time and odds of stock moving way back below your long call are slim. If you think stock could retrace then open a bearish position at higher level maybe with more time to expiration since it is a new position bias

(2) stock moved way ITM and the short call was pretty much intrinsic value plus not much time to expiration - Again odds of stock making that huge swing are slim but if you think it will retrace by a noticeable amount then close bull spread and open new bear spread with more time and at higher strikes.

The point is just because the position in theory gives you a potential extra income if stock tanks, the reality of why you were assigned indicates small probability of results. You will always be better off closing the position and then concentrating on a new position with more time and better strikes relative to where the stock is now.

I always favor banking max profit and then looking at stock anew at the new level based on analysis of the underlying. If you have just 3 days to expiration then sure hold on and see what happens but that is not taking a realistic trading approach. The thought process behind it is not a long term winning one IMHO.

 

[newwurldmn]

Yes but the premise is he was assigned. If the feeling that the stock will now tank hard below $50, in this hypothesis it may still be better to close the bull call spread and then open a new bearish position with more time to expiration since the assignment occurred often because (1) time to expiration is short and time value premium is gone or (2) the spread is waaay ITM.

Definitely. I was responding to the point that why would he not exercise the long option. If his view changes after being assigned he should change his position. But if his view is the same, he should hold the assigned stock + option because his new position is strictly better than his old position.