Small £2500 Accounts Early assignment and margin call

S

Shoptions

Hi I am a new options trader and want to ask the more knowledgeable traders some questions on early assignment and small margin accounts. I have an account size of approx £2500 and I trade on Interactive Brokers.

I sold 1 contract of calls on Facebook trading at $300. If the buyer decides to exercise early and I get assigned the stock I am short 100 shares.

1)I am obligated to sell 100 shares which I do not have so what actually happens?

I assume I would have to buy 100 shares 100 x 300 = $30000 - which I do not have as my account haas only £2500.

1 a) Will my account go into margin deficit and all my positions will be liquidated.....does this mean that all positions will be executed at market price so whether or not they are in a loss/profit they will be closed

1 b) Does this now mean that I will owe Interactive Brokers approx £27500? If so what do they do to try to get the money back?

2) If I can't afford to pay for the 100 x shares does the buyer still receive the 100 shares?

Thanks for any knowledge that you can share.
 
Did you sell a naked call, or is it part of a spread?

And the second part of the question is:

If it is part of a spread, and you get assigned on your short call, you need to tell us whether the long leg of the spread is also in the money, because that can make a big difference in what happens.

BMK
 
If this is a naked call you sold and it appears that it is, you would owe your broker monies. How will they make you pay? They will probably, sue and attach whatever assets you have to recoup the difference. What people do not realize when you sell a call option, you are entering into a contract with another person and required to make good on it if it is exercised. Of course, you could get lucky and the option is never called. Still, know what you are getting into to avoid unpleasant surprises.
 
smallfil wrote:
How will they make you pay? They will probably, sue and attach whatever assets you have to recoup the difference.

Okay, the original post identified the account using the GBP symbol, and I have absolutely no knowledge of how these things work in the UK. But here in the US, what smallfil said is a bit of hyperbole and panic.

If you sell a naked call and it gets exercised, then as the OP said, you will be short the stock. If your account does not have sufficient funds or equity available to support that short stock position, the broker will probably just execute an order to buy the stock back at the market price right after the exercise. And they can do this without any warning. This is commonly referred to as "buying to cover" the short position. It liquidates the short stock position.

Let's assume that you buy the stock back at a price that is higher than the strike price at which you sold it. That means you will sustain a loss. But it might be only a few hundred dollars, and there might be enough cash or equity in your account to handle that.

Under US rules, the broker could issue a margin call and give you up to five days to deposit additional funds to support the short stock position. On a new account with a very low balance, that's not likely. Most US brokers would immediately liquidate the position.

A naked short call certainly can generate a large loss, that could be much more than what you have in your account. And yes, that could lead to the closure of your account, and collection proceedings or a lawsuit to recover the negative balance. But that will not happen every time a naked call gets exercised and you don't have enough money to support the short stock. It depends on the individual circumstances each time.

If the short call is part of a spread, the outcome could be very different.

BMK
 
Shoptions wrote:
If I can't afford to pay for the 100 x shares does the buyer still receive the 100 shares?

Yes. The buyer is protected.

A party holding a call option has a contractual right to buy the stock at the strike price, and that party's rights are guaranteed by the system, through quasi-governmental agencies. Here in the USA, it is the Options Clearing Corporation that guarantees the performance of the contractual obligations associated with options. Other countries have similar agencies.

When you sell a call, your broker guarantees to the government, and to the other party, that the stock will be delivered if they exercise the call. If you don't own the stock, your broker has to lend it to you so that you can sell it at the strike price. That's why you end with a short stock position.

Your broker assumes the risk. If you take a loss, and your account does not have enough money to absorb the loss, your broker has to eat the loss. And then the broker can try to recover that loss from you. But the party on the other side of the trade does not have this type of risk. If they did, nobody would buy or sell options, and the system would not work.

BMK
 
This happened to me, and probably most people. But first, selling a naked call with risk exceeding your cash should not be possible without portfolio margin account. (Not sure, as I have portfolio margin).
However, if you manage to do this or simply end up in that situation, your account will indeed show negative balance (close to -$27500 , approximating 2500 pounds ~= $2500) in this case, but this is ok because you’ll also have the negative 100 shares that will cover it. You’ll then be given a few hours (I think) to buy the shares back, or IB will buy them back automatically, and you’ll end up back with ~$2500, plus/minus the difference that you might’ve made or lost while FB price changed.
Usually IB closes/liquidates margin-violating positions automatically and immediately, but I think in case of assignments they give you the morning or whole day, unless FB price would continue going up and risking to wipe out all of your $2500 cushion.
 
First, it is rare that a call would be exercised early except in limited circumstances (upcoming dividend or a hard to borrow stock). If you are assigned early on a naked call, it becomes a margin issue, not a risk issue.

If you are assigned early on a short call, you then become short stock. There is no more risk here then being short the call and has the opportunity to make more money for you (except if there is an upcoming dividend and if the stock is hard to borrow).

If this happens you will get a margin call and either add money or by back your short stock (or IB will do it for you).
 
BMK said:
Did you sell a naked call, or is it part of a spread?

And the second part of the question is:

If it is part of a spread, and you get assigned on your short call, you need to tell us whether the long leg of the spread is also in the money, because that can make a big difference in what happens.

BMK
More...
Hi, thanks for the reply. I sold a bear call spread.

Bought a call @ $305.
Sold a call @ $300.

It would be good to know what happens if the stock price is between the strikes if early assignment happens on the small account of £2500 as described in the post. Also what happens if the stock price was above the long call if early assigned on a small £2500 account too using Interactive Brokers.

Thanks
 
smallfil said:
If this is a naked call you sold and it appears that it is, you would owe your broker monies. How will they make you pay? They will probably, sue and attach whatever assets you have to recoup the difference. What people do not realize when you sell a call option, you are entering into a contract with another person and required to make good on it if it is exercised. Of course, you could get lucky and the option is never called. Still, know what you are getting into to avoid unpleasant surprises.
More...

Thanks for the response...this is what I fear but different people are telling me different outcomes.
 
BMK said:
Shoptions wrote:
If I can't afford to pay for the 100 x shares does the buyer still receive the 100 shares?

Yes. The buyer is protected.

A party holding a call option has a contractual right to buy the stock at the strike price, and that party's rights are guaranteed by the system, through quasi-governmental agencies. Here in the USA, it is the Options Clearing Corporation that guarantees the performance of the contractual obligations associated with options. Other countries have similar agencies.

When you sell a call, your broker guarantees to the government, and to the other party, that the stock will be delivered if they exercise the call. If you don't own the stock, your broker has to lend it to you so that you can sell it at the strike price. That's why you end with a short stock position.

Your broker assumes the risk. If you take a loss, and your account does not have enough money to absorb the loss, your broker has to eat the loss. And then the broker can try to recover that loss from you. But the party on the other side of the trade does not have this type of risk. If they did, nobody would buy or sell options, and the system would not work.

BMK
More...
Thank you this makes sense. So in reality, if the buyer exercises they receive 100 shares, the broker lends the money to me and buys the 100 shares if the account doesn't have enough money (as in this example of £2500 account) and I end up owing the broker in the example above approx £27500. Hope I have this right.
 
You must log in or register to reply here.
Back
Top