Spreads Trading and Assignment

E

earth_imperator

As is well known, an option vertical spread (for example a shortPut + a longPut)
does reduce the margin requirement vastly, compared to a single shortPut.

Let's say you have such an option spread contract open. For example this one:
Code: 
Spot=105 DTE=30
shortPut: Strike=105 Premium=9.60 (IV=80.1146)
longPut:  Strike=90  Premium=3.60 (IV=83.0780)
The net margin requirement for this spread contract is:
(shortPut.Strike - longPut.Strike) - max(0, shortPut.Premium - longPut.Premium)
= (105 - 90) - max(0, 9.60 - 3.60) = $9 multiplied by 100 = $900.

The net assignment requirement is of course the money required to buy the stock,
in this case (shortPut.Strike - shortPut.Premium) * 100 = (105 - 9.60) * 100 = $9540.00

But what happens if your shortPut gets assigned, but you don't have enough funds in your margin account to fulfill your obligation from the shortPut contract to buy the stock? :p

After all the risk was, thanks to the spread construct, only $900, wasn't it?... :D
 
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See also this text with a very similar example:
https://tickertape.tdameritrade.com/trading/vertical-options-spread-lower-margin-requirement-15634

I just wonder what happens if in case of assignment not enough funds is in the account.
I guess a margin call will be issued. But what happens with the position if still no funds arrive?
I think the broker will forcefully close the shortPut position by buying it back with a loss.
But what happens to the other party that initially issued an exercise?
Something isn't filling up in this process...
 
If you are assigned early on the short side of a put spread, this is a margin issue, not a risk issue. You will have no more risk than you had before (except potential interest charges to hold the stock).

You will need more money to hold your newly assigned stock, but if you don't want/can't add money to your account, you can simply close your remaining position (or your broker will do it for you.). You will be long stock/long put after the assignment and can sell the stock and put together in one trade to close the position. You could also exercise your long put to close as well, but this method isn't advisable unless there is no extrinsic value left in you long put.

Note this applies to early assignment. If you hold to expiration, that's another story.
 
Thanks everybody!
I forgot the effect of the 2nd leg! If an assignment happens then of course my long side is big in plus, meaning my overall requirement from the assignment of course is offset (reduced) by the gains from my long side, resulting in the PnL guarantee of the spread!

So, practically this means: one should sell the profitable long Put position to pay the obligation from the assignment of the short Put position. Some additional cash (the difference) still need to be put in, but that's what the combined spread was guaranteeing in the first place. The missing difference is the said max risk, ie. the loss of $900, and that can usually be paid from the margin account, ie. then no margin call will happen.

So, my assumption that in this spread trade one risks $900, but in reality is forced to have about $9540 or so can be be misunderstood. Yes, that much money one indeed needs when assigned, but the most part of it comes from the gains of the long leg of the spread!... :D
All right then!
Thx, learned another simple lesson today :)
I've to add all these new (for me) facts (of spread trading) and their math formula into my program... :D
 
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FSU said:
You will need more money to hold your newly assigned stock, but if you don't want/can't add money to your account, you can simply close your remaining position (or your broker will do it for you.). You will be long stock/long put after the assignment and can sell the stock and put together in one trade to close the position.
More...
Thx, how is that meant "selling stock and put together in one trade"?
 
Another important observation:

The max loss amount of the spread happens only when the options expire and one is deep in the loss (ie. when spot <= longPut.strike).
But if the assignment happens before the expiry (ie. an "early assignment") then the realized loss will be just a fraction of the max possible loss (ie. in this case less than the max $900).

One can read this from the blue line by varying the "Days from Today" and "Volatility" settings in the lower half of the window of this.
For example when on day 10 the spot is 90 and the (combined) volatility is 80, then the loss will be only 4.38 * 100 = $438, and not the $900 ! This is b/c the options still have 20 days time value...

Another fact is of course this: at expiry the volatility does not play any role anymore, as then only the spot price of the underlying plays a role.


Some outputs of my console program for results at expiry:
Abbrevations: SP=shortPut, LP=longPut, Sx=SpotX, S0=InitialSpot, BE=Break/Even, S=Spot, K=Strike, Pr=Premium
Code: 
  SP(S=105.0000 DTE=30.00 K=105.0000 Pr=9.6000 IV=80.1146)
  LP(S=105.0000 DTE=30.00 K=90.0000 Pr=3.6000 IV=83.0780)

  MarginAcct MarginReq=15.0000 CostBasis=9.0000 NetAssReq=95.4000 MaxPL=6.0000(66.67%) MinPL=-9.0000(-100.00%) S0(PL=6.0000(66.67%)) BE(Sx=99.0000(-5.71%))

  Some select Sx and their results at expiry:
    Sx_at_LP_K=90.0000(dPct=-14.29 PL=-9.0000 PLpct=-100.00)
    Sx_at_(LP_K+Sx_at_BE)/2=94.5000(dPct=-10.00 PL=-4.5000 PLpct=-50.00)
    Sx_at_BE=99.0000(dPct=-5.71 PL=0.0000 PLpct=0.00)
    (Sx_at_BE+SP_K)/2=102.0000(dPct=-2.86 PL=3.0000 PLpct=33.33)
    SP_S=105.0000(dPct=0.00 PL=6.0000 PLpct=66.67)
    Sx_for_PLpct_50=103.5000(dPct=-1.43 PL=4.5000 PLpct=50.00)
    SP_K=105.0000(dPct=0.00 PL=6.0000 PLpct=66.67)
Of course all option premiums to be multiplied by 100 per contract.
 
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earth_imperator said:
Thx, how is that meant "selling stock and put together in one trade"?
More...
You would enter the order as a spread. Sell 100 shares of stock and sell 1 put. Just like any other options spread (call vertical, put vertical, etc) your order will be generally sent to an exchanges COB (complex order book). Here the order will be looked at and filled as a spread, so you will have no leg risk.
 
earth_imperator said:
Thanks everybody!
I forgot the effect of the 2nd leg! If an assignment happens then of course my long side is big in plus, meaning my overall requirement from the assignment of course is offset (reduced) by the gains from my long side, resulting in the PnL guarantee of the spread!

So, practically this means: one should sell the profitable long Put position to pay the obligation from the assignment of the short Put position.
More...

Or save the commissions and the hassle. If you got assigned on your short (assuming you had a debit spread - lower long call, higher short call - invert for puts), then your short was almost certainly out of premium. Otherwise the holder would have sold the call/put.
THEREFORE, your deeper in the money long will absolutely have no premium.
THEREFORE...

----->simply exercise the options.

Total exit of the trade. Single function, low effort, no or very low commission.

NOTE: only works on verticals - not on calendars/diags.
 
misterkel said:
Or save the commissions and the hassle. If you got assigned on your short (assuming you had a debit spread - lower long call, higher short call - invert for puts), then your short was almost certainly out of premium. Otherwise the holder would have sold the call/put.
THEREFORE, your deeper in the money long will absolutely have no premium.
THEREFORE...

----->simply exercise the options.

Total exit of the trade. Single function, low effort, no or very low commission.
More...
Thx, but I could need some additional comment on the above said as this seems
to be a different scenario, b/c my given example was a credit spread,
you say this here is a debit spread.
Unfortunately I need some time to understand it when making such an "extreme" switch... :)
 
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