# Being exercised



## rhmt01 (25 August 2006)

Hi

I am new to options (however have been trading warrants for a while) and have read a couple of books, and in almost all of them they talk about how being exercised is a very bad thing and to avoid it like the plague (such as "The Secret of Writing Options" by Louise Bedford).

I'm just wondering how this actually works, and wondering if the T+3 system comes into play.

Specifically:

If I were exercised on a written call position, couldn't I buy the stock straight away and pay the brokerage and difference?

or exercised on a written put position, couldn't I sell the stock straight away and pay the brokerage and difference?

I would very much appreciate someone who could walk me through the process of being exercised starting from the point where your broker rings you up regarding a ITM option saying that the ACH has picked your lucky number.

Thanks in advance


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## wayneL (25 August 2006)

Hi,

I'm not sure of the mechanics in the Aussie market as I trade the Evil Empire, but just a terminology thing...

If you are short options you are "assigned" which is what you are talking about. When you are long an option, then you "exercise" you option.

So you don't get exercised, you get assigned.

Cheers


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## rhmt01 (26 August 2006)

OK I'll get my terminology right one day. Bedford's book doesn't use the word assign anywhere - she refers to it as "getting exercised".

I've also read Options and Options Trading (Ward) and a few others, but very few of these books deal with assignment, only as a concept of the profitability of early exercise of a bought option.

I wish there was an Australian version covering derivative markerts of "After the Trade Is Made, Revised Ed.: Processing Securities Transactions " by David Wiess, but some things are just something you learn as you go along.

Also in a spread (such as a bull/bear spread), should you be exercised on the ITM component (ie. sold 49 CSL put, bought 48.5 CSL put, CSL underlying 48.90 going ex tommorrow - not that I would do such a thing) what choices do I have with my bought option. If I exercise my 48.5 CSL put would ACH bypass me and assign the writer of the 48.5? (therefore saving me all the broking fees on the underlying).

Thanks


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## NettAssets (26 August 2006)

> Also in a spread (such as a bull/bear spread), should you be exercised on the ITM component (ie. sold 49 CSL put, bought 48.5 CSL put, CSL underlying 48.90 going ex tommorrow - not that I would do such a thing) what choices do I have with my bought option. If I exercise my 48.5 CSL put would ACH bypass me and assign the writer of the 48.5? (therefore saving me all the broking fees on the underlying).



Why would you exercise the bought put when it is 40c OTM ?
If you wanted to wait and see if you get assigned why not short sell at $48.90 (and buy an otm call further out in time  if you want insurance) 

My choice probably would be to buy back my sold position and let the bought put expire worthless.

I was in this exact position on thursday with LHG and proved to myself once again that it is better to close the position a day before where I could have bought the put for half the price that I was forced to pay at close. Its just so tempting to wait when there is only a cent or two to move and everything expires worthless with your money in the bank.
John


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## sails (26 August 2006)

rhmt01 said:
			
		

> I am new to options (however have been trading warrants for a while) and have read a couple of books, and in almost all of them they talk about how being exercised is a very bad thing and to avoid it like the plague (such as "The Secret of Writing Options" by Louise Bedford).



Being assigned is not necessarily a bad thing – depends on your position and how much the broker charges on the underlying share transactions – and this can vary enormously between brokers.  

Example: providing fees are not an issue, assignment on an ITM bull call or bear put spread actually gives max profit without having to do battle with the MM’s to exit at a fair price.

 Also, if there is still time value in the option, assignment may not necessarily be detrimental, but if one has to pay hundreds or thousands of dollars in broker fees, then it avoid it like the plague!

 Also be aware that if assigned on short calls the day before ex-dividend when there is a liability to pay the dividend.  Many of our top option stocks are dividend paying, so it is something to be aware of should you initiate a call spread.



> I'm just wondering how this actually works, and wondering if the T+3 system comes into play.
> 
> Specifically:
> 
> ...



Yes, T+3 can be an issue depending on your broker and is the reason the the dividend becomes a liability if assigned on short calls the day before ex-div. 

The problem is that assignment actually takes place the day before you hear about it – so you are buying or selling the shares the day before you can exercise your option or physically sell or buy to exit the share position.  This means that there will be one day difference in settlement – and some brokers will try to charge a fail fee for that one day.  Check with your broker to see what their policies are on the issue. 

Example:
Day 1 – the option holder contacts their broker with an exercise request and they physically buy or sell their shares on that day.

Day 2 – the option seller is advised that assignment has taken place and the seller will notice that they are now the proud owner of x no of shares or short x number of shares.  Now the option seller has some choices – here are just a couple of the basics: 
(a) if the covering long option is OTM or if it still has time value, it is usually better to just buy or sell the shares to close and then sell the covering long if there’s anything left in it.  If the covering long is not worth selling, just leave it as a lottery ticket! 
(b) contact the broker to arrange exercise of the covering long option if it’s ITM and has no time value left in it - and this will close out the entire position.  

Hope this helps!


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## rhmt01 (26 August 2006)

Thanks for that sails. There was alot of useful info there 

Basically I'm trying to work out what my first spread will be. I'm thinking probably a bull call spread. Definitely a spead due the the whole limited risk thing.

But the key question is what. I have been playing with CSL and MBL warrants for a fair while but I've gotten sick of the market makers. It feels like half the time they know what I hold (with such little volume in installment warrants - they can spot me a mile away and screw me when I'm trying to take a profit. I think they are used to my antics buying 5-10,000 of them for a 1-2 week trade). I feel comfortable playing these underlying but really need to understand how T+3 works as with MBL/CSL, its a matter of $50,000+ a contract should I be exercised and the timing all go wrong.

Should I play in the "sandpit" first, playing with cheap stocks like OSH, SGT and TLS where exercise is costing nearly a twenth of MBL/CSL assignment or is it pretty safe to work with the more expensive stocks and able to deal with the $50k per contract issue due to T+3?

Thanks


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## sails (27 August 2006)

rhmt01, firstly I would suggest that you contact your broker as they really do vary in how they handle and charge for exercise/assignments.  Your broker is the one to give you your answer whether you are able to handle assignments on the likes of MBL and CSL as he/she knows your account size and their policies.  Make sure you ask if they have any fail fees should you be one day short on payment (last time I checked OptionsXpress don't impose any penalties provided you deal with the assignment the next day).  Perhaps check out other option brokers to see if you can get a better deal elsewhere.

With that said, lets take an example of a bull call spread that has gone ITM and one morning there is an email to say you have been assigned.  You will find that you are now short (say 1000) shares, but this is T1 for the purchaser of those shares which means that you will received the funds for their purchase one day before you have to pay to close the position - so T3 works in our favour in this instance.  (Opposite applies for sold puts where you have to buy a day before you are paid!)

So the next trading day, the shares are either bought to close + you sell your covering long to make up the difference (in the unlikely event there is any time value remaining in it) OR you notify your broker to organize assignment of your covering long option.  Either way, you should have the purchaser's payment (based on the relevant strike price) a day before you have to pay for them.

Two things with short calls and bull call spreads: 
1. Be very careful with ITM short calls (or even sometimes close to the money) on the day before ex-dividend day (unless you are hedged with shares and are happy to have them called away) as the probability of being assigned and being liable for the dividend is very high.  

2. Many option brokers have automatic exercise for ITM long options at close on expiry day unless you advise them otherwise.  Make sure you know your broker's policy on this too.

The process of exercise and assignment is fairly straight forward, but the ins and outs of managing them is more involved - and really needs a good knowledge of all the factors affecting option pricing.  Jason (aka Synapse)has written an ebook covering a lot of Aussie option information that is generally not covered elsewhere and has some of it for free - check it out:  http://www.number.com.au/ebook.html

I'm not a licensed advisor or educator and just sharing from my own experience - but hope it helps a little!


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## rhmt01 (27 August 2006)

Thanks again sails, especially for the link 

Page 35 of Synapses book goes through some examples of some high value shares being exercised... so its only the difference/brokerage/ach fees that I have to ante up with.

As for the broker issue, I am currently with Avcol, but unhappy with their service. They get quite annoyed when you tell them to start at midpoint of the spread, and slowly move to edge of the MM spread to get a bite. Plus I don't know whats happening with the whole JDV thing and having to re-sign my derivatives PDS/chess/etc... does that mean they've outsourced my to some new brokers in Perth or something?

I am tossing up between either Morrison or OptionsXpress. The US paperwork that OX has sent me is a bit daughting (form W8BN n stuff... next thing I'll get is a W1080 or something from the IRS). And the fact that I can get someone on the phone at Morrison if the s*** hits really the fan has things going for it. There was also a recent ad in the daily telegraph with this new phone broker - www.norrissmith.com.au offering flat rates for everything.

I've decided to spend money doing small trades in the sandpit with small share values for a couple of months. Try every scenario such as intentionally getting assigned on an ITM put and call on something small (underlying <$4) on 1 contract only just to go through the experience of the whole process and lose my "assignment" virginity in a controlled environment.

Reading everyone here it seems the best thing to do is experience it all and learn; the short term spending on alot of brokerage will benefit more in experience and confidence in the long run than running round with $50k exposures with no idea and sleepless nights


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## Magdoran (27 August 2006)

rhmt01 said:
			
		

> Hi
> 
> I am new to options (however have been trading warrants for a while) and have read a couple of books, and in almost all of them they talk about how being exercised is a very bad thing and to avoid it like the plague (such as "The Secret of Writing Options" by Louise Bedford).
> 
> ...



Hello All,


Tried to post this last night, but the ASF site keeps bugging out, so some of my comments may overlap with Margaret’s post this morning.

Ok rhmt01, firstly, the correct term in Australian terminology is being “exercised”, assignment is the same thing, but the term is commonly used in the US markets.

Secondly, T+3 generally applies to shares and not options.  Options are typically settled T+1 (this is true of exercising; the option writer is obliged to fulfil the contract at T+1).  Certainly if you have to purchase or sell shares in the process, you will settle these T+3, but the option obligation must be settled at T+1 (that means by the end of the trading day once you receive the notice).

Thirdly, being exercised is often not a bad event in certain circumstances, provided you’ve worked out your strategy and risk correctly at entry.  It’s happened to me and it’s no big deal if you know what you’re doing. But certainly, knowing the mechanics is vital if you’re gong to be selling options, so please do study this in detail.

Also, consider that this applies to stock ETOs, and that index options may be European exercise, so these work differently. The comments here refer to American exercise.

How you respond to a sold position being exercised depends (as Margaret has correctly outlined) on the strategy you used, and the market conditions.  Sure, to fulfil the contract you can buy the underlying if exercised on a short call, or sell the underlying if exercised on a short put.  But if you have a bought position like in a bull call, bull put, bear call or bear put, it may make sense to exercise this position in order to fulfil your obligation if this is to your advantage.

In the case of a bull call or a bear put, if the sold position is ITM and exercised, this usually means that you will automatically realise the maximum profit because you can then exercise the deeper ITM bought position, and pocket the difference (the only cost here is the cost to exercise your position).

Where you are exiting at a loss for say a bull put or bear call, by exercising the bought position you may lose the time value if you exercise it, so consider retaining the bought leg if you deem this to be strategically the best course of action (certainly if reversing the direction has a good probability of success by keeping the bought leg).  Alternatively you could wind out the bought position in the options market after buying/selling shares to fulfil the exercised option.

You may also elect to keep any shares you receive if you wish, or just sell the shares you own if for instance you were executing a covered call, and leave it at that, but this is a personal decision based on your broader strategy.

Margaret makes a good point about short Calls being exercised the day before ex-div.  This is very common for positions with little or no time value to be exercised around ex-div time.  Depending on the conditions (volatility and where ITM/ATM/OTM you entered the position), it may make sense to wind out the position before this happens, because you will owe the dividend in the stock if exercised in this way.  However, if the time value premium more than off sets this with longer dated strikes, you can profit from this kind of transaction depending on the dividend, and the premium paid, but you really need to think this through very clearly.

I used to trade warrants too, so be careful when trading low open interest options, they do trade quite differently.  You really need to know your Greeks and how to play the market makers since there is definitely slippage and volatility shifts to consider.

Hope this helps

Regards


Magdoran


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## rhmt01 (27 August 2006)

Thanks Magoran.

So if I had a position:

Bought RIN 13.23 Sept Call
Sold RIN 13.69 Sept Call

Underlying at 13.90 on the two days before expiry.

If I am exercised on the sold 13.69 call and notified the next day (the day before expiry), if I exercise my bought 13.23 call does it cancel out or would there still be a share transaction?

On the same note, if I had the same position and price on underlying on expiry day and I exercise my bought position and the sold position is exercised would there be any (share) transactions.

I understand that stocks at T+3 and options are T+1, but I am just seeing what the "crossover" is when exercised, as you move from the options T+1 world with either a pile of cash (sold call exercised) or a pile of shares (sold put exercise).

Does that mean I have 2 days (T+3 minus 1 day of notification) to correct the situation (buy or sell) or do I have to do everything the day the broker tells me I have been exercised?

Just trying to understand the timing and brokerage implications of being exercised.


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## wayneL (27 August 2006)

Magdoran said:
			
		

> Ok rhmt01, firstly, the correct term in Australian terminology is being “exercised”, assignment is the same thing, but the term is commonly used in the US markets.




Mag,

This may seem to be a pedantic point on the issue of terminology, but has the potential to be an important one.

"Being exercised" be be a term in popular usage amongst retail traders, obviously promulgated by amateur tomes such as Secrets to Writing Options, but it is most definately not correct terminology; not even in the United States of Australia. Unfortunately is has become entrenched in the trading vernacular, but this does not make it correct.

When an option owner "exercises"' their option, the writer of the option is "assigned". This is the correct terminology as this document from the ASX clearly illustrates:



> ASTC FAIL FEE WAIVER REQUEST - *ASSIGNMENT OF CALL OPTIONS TO UNCOVERED WRITERS*
> Due to the overnight batch processing of ACH operations, an exchange traded call
> option writer is not notified of their *assignment* until T+1 even though the *exercise* notice is lodged by the taker (the owner of the option) on the previous trade date (when the subsequent “as
> at” equities transaction becomes effective).
> ...




http://www.asx.com.au/investor/pdf/notices/2004/Clm13504.pdf

There is a very good reason for standardized terminology across all markets and that is to avoid the possibly disasterous consequences of confusion.

The taker (buyer) of the option exercizes.

The writer (seller) of the option is assigned.

Cheers


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## rhmt01 (27 August 2006)

I'm just trying to understand how to defensively handle assignment...

From my calculations, the cost of brokerage of the underlying (2 sides) is going to be the big issue especially for the likes of CSL and MBL.

Is it possible (such as 2 days before expiry) once assigned to run out and buy an in/at the money option and exercise that on the same day and avoid any stock transactions (and stock brokerage)?


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## wayneL (27 August 2006)

rhmt01 said:
			
		

> I'm just trying to understand how to defensively handle assignment...
> 
> From my calculations, the cost of brokerage of the underlying (2 sides) is going to be the big issue especially for the likes of CSL and MBL.
> 
> Is it possible (such as 2 days before expiry) once assigned to run out and buy an in/at the money option and exercise that on the same day and avoid any stock transactions (and stock brokerage)?




rhm,

I'll leave the brokerage considerations to the others, bit if your sold leg is substantially ITM 2 days before expiry, it is likely that your spread will be in profit by > 90% of its ultimate profitability.

Under these circumstances, here are a couple of reasons to *think* about simpley closing out the spread and taking the ~95% profit or otherwise sidestepping assignment/exersize.

1/ Your risk/reward is now radically different to when you put the trade on. You now have VERY little more upside potential and a massive amount of downside. The stock could move up $10 and it would mean very little to your overall profit/loss. However if the stock moved down $10, it has just cost you a bundle. Leaving the trade on only to watch the stock move top below the sold strike... or worse still below the bought strike in the days preceding expiry is a major p!ss off.

2/ That 5% or so of foregone profit may just be cheaper than the commission on exercize/assignment... depending on how your broker charges you.

3/ You could roll or morph the position to something else, depending on your view.

Just a couple of things to consider.

<Note; this was added after Netassett posted> ==> As to your question. If you have already been assigned early, you cannot avoid the share transaction and will require on offsetting share trasaction to rid yourself of the position. 

Obviously, unless this is what was initially intended, it will introduce a new risk. It must be said however that there must be a financial incentive for the taker to exersize early (unless he is a cerytifiable idiot) such as a dividend payable. Otherwise early call exercize is not likely.

Please note that ITM puts are likely to be exercized early when the share cost of carry exceeds the remaining extrinsic value in the put.

Cheers


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## NettAssets (27 August 2006)

rhmt01 said:
			
		

> I'm just trying to understand how to defensively handle assignment...
> 
> From my calculations, the cost of brokerage of the underlying (2 sides) is going to be the big issue especially for the likes of CSL and MBL.
> 
> Is it possible (such as 2 days before expiry) once assigned to run out and buy an in/at the money option and exercise that on the same day and avoid any stock transactions (and stock brokerage)?




Once you are assigned the shares from a sold option position there is no way to avoid a share transfer.

*and*

Once you exercise your option in a long option position there is no way to avoid a share transfer - one transaction does not cancel out the other.

The only way to avoid a share transaction is to trade out of the option position *before exercise happens*.
That is to "buy to close" the equal number of contracts to offset a short option position or "sell to close" the equal number of contracts to offset a long option position.

John


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## rhmt01 (27 August 2006)

OK thanks for that.

I will just need to calculate getting out of the bull call spread in my calculations as well.

Is there any particular day (numerically) before expiry do the MM start putting up the price of getting out of a spread?

Also, although one transaction does not cancel out the other, I guess they will be matched though in time? (that is, the shares from assigned call and your exercised call)


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## NettAssets (27 August 2006)

From my experience it usually only starts going up on exiry morning and if the shares haven't traded OTM before lunctime expect to be paying at least double the calculated price - at 5 mins to close it could be anything- you may as well forget it and go through the assignment.
John


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## NettAssets (27 August 2006)

In the spreadsheet I use to watch my positions I always add the entry and exit brokerage and fees in to the total investment right from the start. That way I know what the position is going to be on any day John


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## wayneL (27 August 2006)

rhmt01 said:
			
		

> OK thanks for that.
> 
> I will just need to calculate getting out of the bull call spread in my calculations as well.
> 
> Is there any particular day (numerically) before expiry do the MM start putting up the price of getting out of a spread?




Just a point. When the vertical spread is left till expirey, exercize/assignement is the only way to crystallyze your profit.

Market Makers do not put up prices before expirey. Any funny business will be quickly arbed away. However the the trading activity of traders exiting option positions prior to expiry may push prices around somewhat.

Option Pricing Models are notoriously innacurate in the days before expity and this is one of the reason why. Just do your summs at the time.

In my trading, anytime I can get more than 90% profit I will close or morph, irrespective of anything else.



			
				rhmt01 said:
			
		

> Also, although one transaction does not cancel out the other, I guess they will be matched though in time? (that is, the shares from assigned call and your exercised call)




Providing both happen at expiry, yes.

Cheers


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## wayneL (27 August 2006)

rhmt01 said:
			
		

> ...that is, the shares from assigned call and your exercised call)




Just a further point.. see how correct terminology removes any ambiguity? 

It is now patently obvious by correct terminology that one option is short and one is long.

Good stuff!

Cheers


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## Magdoran (27 August 2006)

wayneL said:
			
		

> Mag,
> 
> This may seem to be a pedantic point on the issue of terminology, but has the potential to be an important one.
> 
> ...



Hello Wayne,


I remember the opening song early in “When Harry Met Sally” - I say “Tomarto” and you say “Tomayto”…  

Sheesh Wayne, you are getting pedantic in your old age, aren’t you? – crypt not big enough these days?  Or did you drink too much blood last night?  Hehehehe….

Awwww, come on you escaped Californian, in Australia we’ve used the term “exercise” price, but later adopted “strike” price form the states, we used to use the term “share market” which is now interchangeable with “stock market”… we use “exercised” and “assigned” as interchangeable too…

Also, the term can be used in different tenses to describe the situation covering both parties... it really gets down to semantics and language usage.

Sure, the current rules use the term assignment now, but everyone in Australia understands what being “exercised” means, it's been used by the whole financial market since as far back as I can remember, and I’m in my 40s… In the early days of options, everyone I knew used the term “exercised”… Many Australian texts use the term, as does the ASX site (see below).

http://www.asx.com.au/investor/options/trading_information/early_exercise.htm

Here for example is a quote from the ASX site from the link above:  



> For in-the-money calls where the corresponding put still has some value, the rule used by most of the market is that if the value of the dividend is more than the value of the corresponding put plus interest, then the call should generally be *exercised * for the dividend.
> 
> Writers of call options who want to avoid assignment (being *exercised * against) may need to either buy back or roll that short call position to another strike in another expiry, being mindful again that the option they roll to is not also a candidate for early exercise.
> 
> ...




Also see:



> Further, when *exercised * the option writer looses the stock when *exercised*. Profit Loss Outcomes of the Buy Write Strategy at Expiry CBA stock price Stock change $31




http://www.asx.com.au/research/indices/buy_write_example2.htm

Really, I don’t think this is an important issue in Australia where the term has been used for decades...  but if you feel the urge Wayne, be my guest, but I’ll respond to either term equally like the rest of the Australian financial industry whenever I see the term used...

Yours in Amusement


Magdoran


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## Magdoran (27 August 2006)

wayneL said:
			
		

> Just a point. When the vertical spread is left till expirey, exercize/assignement is the only way to crystallyze your profit.
> 
> Market Makers do not put up prices before expirey. Any funny business will be quickly arbed away. However the the trading activity of traders exiting option positions prior to expiry may push prices around somewhat.
> 
> ...




I concur with this approach.  Generally I’d prefer to wind out a debit spread before it gets too close to expiry (generally around the 30 days to expiry range), and certainly would consider exiting when at 90% profit, this makes good sense to me.

Wayne is quite right about the odd things that happen around expiry time – there is a lot of juggling to avoid “pin risk” for example where the underlying closes exactly at an exercise price on the expiry day.

Regards


Magdoran


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## wayneL (27 August 2006)

You must admit it introduces ambiguity and further clarification and explanation as to whether the position is long or short.

By the mere use of the correct term, "assigned" settles the matter conclusively. 

As the Evil Empire is unaminously regarded as the centre of the universe (a situation that will change shortly I'm sure) and in fact, the inventor of the instrument, I believe we should at adhere to to the nomenclature as proposed by them.

As regards to my pedancy; The lack thereof has proved costly in times past, igniting a passion for all things pedantesque. 

In fact the most fanatical pedagogue of all was The Original Count himself with regards to the exact time of sunrise. 

The murderer of said Count, I'm sure was rather pedantic about the exact metalurgical composition of his bullets... and yes only a wooden stake would do.


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## Magdoran (27 August 2006)

wayneL said:
			
		

> As regards to my pedancy; The lack thereof has proved costly in times past, igniting a passion for all things pedantesque.
> 
> In fact the most fanatical pedagogue of all was The Original Count himself with regards to the exact time of sunrise.
> 
> The murderer of said Count, I'm sure was rather pedantic about the exact metalurgical composition of his bullets... and yes only a wooden stake would do.




I'm killing myself right now - ROTFLMAO!  

Mag


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## wayneL (27 August 2006)

NettAssets said:
			
		

> From my experience it usually only starts going up on exiry morning and if the shares haven't traded OTM before lunctime expect to be paying at least double the calculated price - at 5 mins to close it could be anything- you may as well forget it and go through the assignment.
> John




John

Can you give an example of this? Doesn't have to be real, just so I can see what you mean.TIA

Cheers


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## NettAssets (27 August 2006)

Hi Wayne

LHG thursday
Trading range open 2.97 close 2.92 traded up to 2.98 
from memory my backtester wont grab the series at the moment
LHGLS $3.00 put overnight fair value @ 2.97 .035
opened at .050 / .015
around noon trading at 2.95
.08 / .009
didn't watch the close on this one

from a similar experience .20 / .00 wouldn't suprise me.
John


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## wayneL (27 August 2006)

NettAssets said:
			
		

> Hi Wayne
> 
> LHG thursday
> Trading range open 2.97 close 2.92 traded up to 2.98
> ...




John 

What would happen if you put a bid in a cent or two above intrinsic value?


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## NettAssets (27 August 2006)

I had a bid in at 4c that didn't get picked up.I traded at lunchtime and had to go right up to the ask It was touch and go at that point whether I would have been better off to short sell the shares and wait for assignment.  There was too big a bundle for me to buy unfortunately
John


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## Magdoran (28 August 2006)

rhmt01 said:
			
		

> I'm just trying to understand how to defensively handle assignment...
> 
> From my calculations, the cost of brokerage of the underlying (2 sides) is going to be the big issue especially for the likes of CSL and MBL.
> 
> Is it possible (such as 2 days before expiry) once assigned to run out and buy an in/at the money option and exercise that on the same day and avoid any stock transactions (and stock brokerage)?







			
				NettAssets said:
			
		

> Once you are assigned the shares from a sold option position there is no way to avoid a share transfer.
> 
> *and*
> 
> ...



The issue of fulfilling assignment needs to be clarified since there is some ambiguity in the mechanics described in both quotes.

For example let’s look at the mechanics involved with a bull call spread which is about to expire which has moved deep in the money.

The sold call is ITM and is exercised by the taker of the call.  The writer of the sold call who established the bull call spread is now obliged to fulfil the contract by delivering (in Australia) 1000 shares per contract to the taker.

The writer with the bull call spread has several options open to fulfil the contract.

1) Inform their broker that they wish to exercise the bought call(s) and fulfil the requirements of the exercised (assigned) calls (which formerly comprised the sold call(s) position).  The broker then delivers the stock to fulfil the contract, and awaits the delivery from exercising the bought call(s) to balance the transaction the next day.  It is not necessary to actually buy or sell the stock, just exercise the bought call(s) – one transaction.

This may depend on individual brokers, but in my experience most brokers will allow you to exercise an ITM bought position in spreads like a bull call to satisfy a sold position that is exercised (assigned) - My full service broker certainly does.

You would only do this though if there was no time value in the bought call, and it was expedient to do so, and you wanted to wind out the position at that point.

2) Buy the required amount of shares in the market to fulfil the contract, and retain the long call(s) – assuming that the underlying will continue favourably, or that there is time value in the bought calls (in which case these could be sold separately at the most opportune time and not lose the time value which they would lose if they were exercised).

3) If the writer owned sufficient quantity of the underlying stock, they could inform their broker to take stock from their holdings to fulfil the contract if they wished.

4) If allowed (there can be some restrictions on this), the writer could if permitted by their broker and the exchange rules go short the underlying at the exercise price required by the taker, and inform their broker to match up the transaction.  This requires that the broker would allow the issue of the same quantity of short stock to fulfil the contract.  The writer’s account would then reflect the corresponding number or short shares transacted at the strike price.

So, yes it is possible to buy a call and exercise it on the day if you wished to fulfil an obligation, but you’d be paying for the option transaction, and the cost of exercising the call…

I hope this clears the matter up.


Regards


Magdoran


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## NettAssets (28 August 2006)

Magdoran said:
			
		

> 1) Inform their broker that they wish to exercise the bought call(s) and fulfil the requirements of the exercised (assigned) calls (which formerly comprised the sold call(s) position). The broker then delivers the stock to fulfil the contract, and awaits the delivery from exercising the bought call(s) to balance the transaction the next day. It is not necessary to actually buy or sell the stock, just exercise the bought call(s) – one transaction.
> 
> This may depend on individual brokers, but in my experience most brokers will allow you to exercise an ITM bought position in spreads like a bull call to satisfy a sold position that is exercised (assigned) - My full service broker certainly does.




Does this mean that you pay no commission for the share transfer Magdoran.
Are the costs for exercise the same as the costs for trading the option position. 
I have not gone through exercise yet but my understanding is I have to pay both for the exercise instruction and the share transaction.
John


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## wayneL (28 August 2006)

Magdoran said:
			
		

> 1) Inform their broker that they wish to exercise the bought call(s) and fulfil the requirements of the exercised (assigned) calls (which formerly comprised the sold call(s) position).  The broker then delivers the stock to fulfil the contract, and awaits the delivery from exercising the bought call(s) to balance the transaction the next day.  It is not necessary to actually buy or sell the stock, just exercise the bought call(s) – one transaction.
> 
> This may depend on individual brokers, but in my experience most brokers will allow you to exercise an ITM bought position in spreads like a bull call to satisfy a sold position that is exercised (assigned) - My full service broker certainly does.
> 
> *You would only do this though if there was no time value in the bought call, and it was expedient to do so, and you wanted to wind out the position at that point.*




Great point Mag and one that deserves to be highlighted.

Amazingly, and stupifyingly, some brokers force the early exercise of the bought call when the short call has been assigned, *even if there is substantial time value left*.  This explains the otherwise inexplicable early assignment of short calls

If this ever happens (the forced exercize of long calls), people should change their broker forthwith.

Cheers


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## Magdoran (28 August 2006)

NettAssets said:
			
		

> Does this mean that you pay no commission for the share transfer Magdoran.
> Are the costs for exercise the same as the costs for trading the option position.
> I have not gone through exercise yet but my understanding is I have to pay both for the exercise instruction and the share transaction.
> John



Hello John,


Most brokers have a set of scheduled fees where options transactions and exercise fees are usually treated as different categories – the cost to exercise is usually much more expensive than an options (and often a share) transaction.  

But this differs from broker to broker.  Some may well charge differently - I use several different brokers in Australia, and they all have similar mechanics as described, so I have not encountered the approach you are describing, but it could be the structure of your current broker.

Using the bull call example above (based on the arrangement that I have with my brokers) you shouldn’t be charged for being assigned, but you would be charged to exercise the bought call as one transaction, not two.  

If you bought shares though, you’d be charged for this, and if you sold your bought call separately, this would be treated as a separate transaction.

So, no, generally the cost of exercise is usually dearer than an options transaction, and yes, if you are able to use this kind of transaction you wouldn’t pay commission for the share transaction, but you should clarify this with your broker.


Regards 


Magdoran


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## Magdoran (28 August 2006)

wayneL said:
			
		

> Great point Mag and one that deserves to be highlighted.
> 
> Amazingly, and stupifyingly, some brokers force the early exercise of the bought call when the short call has been assigned, *even if there is substantial time value left*.  This explains the otherwise inexplicable early assignment of short calls
> 
> ...



Hello Wayne,


Thanks…


Re forced exercise - That’s pretty poor if you are forced to exercise a bought call prematurely without being given the option to retain the value if possible…  

With my current brokers, my understanding is that you are given the options outlined above, but must conclude the transaction by a certain time of day if your account balance or share balance is insufficient to cover the transaction, but you are also given the opportunity to increase your account balance as collateral if required (usually if assigned with a sold put) or purchase the stock in the case of sold calls.

If I had time value left, I’d certainly look to finding the best way to realise this value, or retain it…

I usually deal with bull puts though where your account suddenly has a whole lot of shares added to it when the sold put is assigned – which can be interesting depending on your account size, and the number of contracts involved.  

One day I logged on to find a big red number in my cash balance, and a wad of shares in my position area. I’d stuffed up a position, and sold the wrong month by accident, and got assigned. So, I waited to wind out the position by selling the shares later that day… 

It cost me about $500 USD (not huge, but irritating to throw money away via error) at the time though because the stock had moved against me overnight, and the bought put didn’t appreciate because it was so far OTM with not enough time value I couldn’t wind it out for a credit… learnt my lesson to pay attention to the expiry month (sometimes I didn’t know what day it is when trading the US because you become nocturnal like Wayne – what day is it today “Dracula”? Hahahaha…)

So, I agree, if your broker forces the exercise of calls without giving the above options, I’d be looking for a new broker, and cancelling my account (I have actually done this in the past, and won’t stand for any substandard treatment).


Regards


Magdoran


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## rhmt01 (28 August 2006)

Thanks for all that...

I've done a fair few things today.

Spoke to a few brokers (since I'm currently in the middle of brokers - I haven't signed my JDV stuff so I won't be with avcol past the end of September). Based on this discussion and the attitude of the broker, I have chosen to move to Norris Smith at the end of the month.

He gave me a few choices.

1. I could cop the fail fee every day I'm out, being the higher of $50 or 0.1%. He doesn't mind as long as hes kept informed (unlike others that would threaten you with closing your account for continual fails). Thats $50 per contract on CSL or $60 or $70 on an MBL or RIO.

2. Settle the assignment though my BT margin loan account. OK for smaller options, but the fail fee option doesn't require moving 25%-30% of the assignment value (at $15-$25,000 for CSL/MBL/RIO)... so about $13/per day/per $50,000. Over a weekend the fail fee is roughly the same without the money transfer madness!

3. Have the cash ready on assignment day.

He was very helpful and spoke about my other concerns (such as the bad attitude of some brokers when you ask them to move the spread etc). I think I have found a full-service non advisory broker (if there is such a thing).

After all this I am no longer in the dark about the concept of assignment and actually looking forward to my first one (hopefully on a bull credit spread).

Thanks to all.


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