# Options assignment broke through my max risk!



## investedz (19 May 2009)

Hi guys,

This is based on a US option trade, but just wondering if it happens here in our Commsecs and eTrades.

So here it goes:

About a month ago, I opened a bear call spread position on GOOG (google), anticipating a bear trend on the stock. The credit trade consisted of a short May 380 call, and a long May 390 call (for a credit of 5 points).

As the days went by closer to expiration date, the stock price rose against my bearish outlook.

However this didn't phase me, I already knew my max risk. By expiration the trade was out of the money, and I would have accepted my max loss of 5 points.

Then Monday came, and as it turns out, the stock closed on Friday @ EXACTLY 390.

This means that although the short call was exercised at 380, the long call I had expired worthless. I was now sitting on 100 short stocks!

To top that off, I was margin called during the weekend (how convenient), so my short shares were placed on market order, GOOG opened up this morning @ 394 ...

So there goes my max risk out the window. Went from 5 points to 9 points!

Had GOOG opened up at 400+.... I would have been in deep deep trouble.

So as it turns out, the long options that are supposed to cover our short options aren't so protective at all!

Anyone have any insight on this?


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## cutz (19 May 2009)

Yeah, 

This phenomenon is call pin risk, the stock closes at exactly the strike and assignment may or may not happen, it can happen with any broker. 

Assignment it’s outside of the brokers hands, it’s actually a random selection by the options clearing house. (random in the sense that if open interest was 1000 and the stock was pinned to the strike but only 100 contracts were exercised. One would assume that all ITM options are assigned so that wouldn't be so random)


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## jackson8 (19 May 2009)

investedz said:


> Hi guys,
> 
> This is based on a US option trade, but just wondering if it happens here in our Commsecs and eTrades.
> 
> ...





hi
most op traders never let their positions go to expiration, they will close out especially in your case to avoid the pin risk of being excercised. we dont want the stock only the premiums received from the shorts

or you could have rolled the shorts out and up to the next month or two and purchased insurance and do it all over again, would have lessened your profit and you dont mention how many contracts so in reality may not have been worth it to do this and would then be hoping for a down move for this to work.

also us. brokers have a reputation of not leaving much room to move when it comes to ex and margin , pays to understand their ex and assig and margin req. policies in depth

gary


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## sails (19 May 2009)

Hi Investedz,

So sorry to hear of your painful learning experience.  Yes, it is pretty much another option gotcha and not always taught in option education.  It is something that happens at expiry and has been discussed on ASF previously - it may have even been in the "Option Gotcha's" thread - I can't remember now.

In a vertical spread, you are protected by the long option only during the life of that option.  Once the stock closes on expiry day - that long option is no longer there to protect the short - unless it is sufficiently (ITM) in-the-money for you to request exercise.  If you had fully understood this, there are other strategies to ensure your max risk was not exceeded.  For example:

1.  Buy to close the entire spread as there may have still been a little bit of time value left in the long if closed out earlier in the day meaning you possibly could have lost a bit less that the max risk. - OR

1 (b) Buy to close the short before the end of trading on expiry.  This is usually a good rule of thumb of ever the market is trading near your short strike on expiry day - even if it's slightly OTM as sometimes there can be news on the stock after the market closes and shorts that looked to be safe when the market closes can still be assigned for some time after the market closes - I believe different brokers may have different cut off times for retail traders to request exercise of their long options, but I think MMs have a longer window of opportunity.

2.  As your short call was firmly ITM, the risk of exercise is extremely high - almost a given.  In this case, you could have then exercised your long call to hedge against almost certain assignment of your short call - and this would have kept your spread within the original max risk amount.

Depending on the price available, I would prefer the first choice above as there is a chance of paring the loss a little and it means you are fully in control.

Same goes here in Oz options trading and using Oz brokers would not have made the slightest bit of difference - unless they were full service and were kind enough to let you know.  It astounds me that option educations don't seem to address some of these issues.

So, the bottom line is that any protection given by long options dies with expiry - and so it requires other protective strategies (such as above examples) to ensure your max risk is not exceeded.  As a rule of thumb I like to close out any short options that are close to the money by expiry day at the very latest.

Another gotcha is that even long options that are only just ITM are often automatically exercised by the broker - which can leave you with a share position you don't necessarily want the next day.  Most brokers allow you to request they don't auto exercise your longs - but make absolutely sure you know what their policy is and by how much ITM before their auto exercise kicks in.  This is a different situation where you think you have all the rights as a buyer, but then find the position has been auto exercised and you are left with an unhedged share position the next morning - or over the weekend as is the case in the US.

Oh, and one more gotcha with assignment - always know when your stock is going X-dividend as short ITM calls are ripe for early exercise - if that happens, it leaves one short stock on X-div day PLUS the liability to pay the dividend.  In the case of a call spread, the long call doesn't give any protection for the dividend liability.  Best to avoid or close out bear call spreads prior to the stock going X-div.

Hope this helps...

EDIT: Cutz - I understand his short call was firmly ITM at 380 - the long was at 390 and expired worthless.  If GOOG had moved up a little more, his long probably would have been auto-exercised and spared the extra loss.  But then he would think that was normal and possibly get burned with larger quantity somewhere down the track when he's in a situation where the short call is even slithgly ITM.  Yeah, pin risk is something one seems to have to learn by mistake...


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## bunyip (19 May 2009)

investedz said:


> Hi guys,
> 
> This is based on a US option trade, but just wondering if it happens here in our Commsecs and eTrades.
> 
> ...




Not being an options man, I can't make any worthwhile comment on the options side of your trade.
But I'm perplexed as to why you anticipated a bear trend in this stock about a month ago.

The chart shows that Google was in a new but clearly established uptrend throughout April. Once established, uptrends usually continue higher. 
A simple method of predicting the future direction of stocks is to find those that are currently trending strongly, then assume they'll trend further in the same direction. You'll be right more often than wrong.


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## Timmy (19 May 2009)

bunyip said:


> Not being an options man, I can't make any worthwhile comment on the options side of your trade.




Yeah, not an options man either, but a question ...




investedz said:


> The credit trade consisted of a short May 380 call, and a long May 390 call (for a credit of 5 points).
> ...
> Then Monday came, and as it turns out, the stock closed on Friday @ EXACTLY 390.
> 
> This means that although the short call was exercised at 380, the long call I had expired worthless. I was now sitting on 100 short stocks!




OK, so on Friday you knew you were going to be short Google at 380, right?
So, why didn't you buy the shares on Friday to cover your risk?  Or, why didn't you exercise the call at 390 which also would have covered your risk?  Were you happy to be short over the weekend?  Looks like to me you decided to punt on buying in your short Google share position at a price lower than 390, right?


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## cutz (19 May 2009)

cutz said:


> Yeah,
> 
> This phenomenon is call pin risk, the stock closes at exactly the strike and assignment may or may not happen, it can happen with any broker.
> 
> Assignment it’s outside of the brokers hands, it’s actually a random selection by the options clearing house. (random in the sense that if open interest was 1000 and the stock was pinned to the strike but only 100 contracts were exercised. One would assume that all ITM options are assigned so that wouldn't be so random)




Sorry I just reread and realized your predicament, your longs weren’t auto exercised because the stock was pinned to the strike, I haven’t got anything else to add other than credit spreads really aren’t set and forget. Sails pretty much summed it all up.

Best of luck on this position, if things turn pear shaped you may even have a win.


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## freddy2 (19 May 2009)

As the saying goes "If you can't spot the sucker in the first 30 minutes, then you ARE the sucker!"


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## cutz (19 May 2009)

freddy2 said:


> As the saying goes "If you can't spot the sucker in the first 30 minutes, then you ARE the sucker!"




G’Day, 

I think you’ve stumbled across the wrong thread, Investedz's position may yet indeed become profitable, and his bias hasn’t changed, i.e a bearish position has remained a bearish position, googles chart now looks bearish to me ( but i may be wrong, not a T/A expert ).

The question is now, are you the sucker???


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## sails (19 May 2009)

Timmy said:


> ...OK, so on Friday you knew you were going to be short Google at 380, right?
> So, why didn't you buy the shares on Friday to cover your risk?  Or, why didn't you exercise the call at 390 which also would have covered your risk?  Were you happy to be short over the weekend?  Looks like to me you decided to punt on buying in your short Google share position at a price lower than 390, right?




Timmy, judging by his first post in the this thread, it would appear that he believed the long call would protect his short position and was completely oblivious to the effects of expiry on his total position.

Any formal "education" I did was more about selling further software, selling the next course/s, etc - and hyping people up on this supposedly amazing way to make money.  Education on expiry issues is so often glossed over or missed entirely, so most newbies fresh out of an options seminars rarely have any idea whatsoever of these things.  

I actually learned far more from internet forums and fortunately learned some of these nuances before getting badly burned.  It's one of the main reasons I am willing to  return the favour of free education especially in the area of optons.


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## investedz (19 May 2009)

Thank you guys for your input, and thanks Sails for the info.

Yes my mistake was I assumed too much.

In the past I was lucky enough for the trade to expire in the money, or out of the money, but never in between, which is my case now.

My account balance was actually not enough to cover this (less than half the $39k of shares that was assigned), and I wouldn't have been allowed to short sell these amount of shares if I wanted to place my own order.

So the big assumption was that when I got assigned the shares, I assumed I would automatically be margin called.

Just a note that I'm not worried about the loss, it was more of the greater loss than expected.


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## Mark Wolfinger (21 May 2009)

investedz said:


> Hi guys,
> 
> _Then Monday came, and as it turns out, the stock closed on Friday @ EXACTLY 390.
> 
> ...





*They are protective.

You just made a big mistake.  You should have exercised your long 390 calls and that would have been the end of the story.

Mark*
http://blog.mdwoptions.com/


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