# Covered Call: ACH reject the stock being optioned



## xtanda (11 December 2008)

Hi guys,
Just want to share my experience with this unreasonable policy by Australia Clearing House (ACH) related to covered call a.k.a buy-write or  "share renting"

*You will not believe this*:

I did covered call on OZL for Dec 08 expiry on late November
Early December , as we know, OZL request to suspend their securities pending some refinancing issue
 Several days later I got margin call for my broker requesting to deposit cash margin despite I have 100% coverage on the call option with OZL own stock.

*It's covered call*: I have covered it with the stock itself (OZL stock for OZL option), why I should still deposit some cash margin? I cannot figure out any possible explanation except ACH does not know what they are doing. The cash margin is just to make sure the writer can buy the stock at market and sell it cheaper (hence making a loss) in case of exercise, but if I have the stock already - end of story, right? What do you think ?

Frankly, I thought firstly that this is just the broker playing up. But after they provide me with ACH formal notice and received 'release from cover' letter then I realize it's not the broker...

What do you guys think ? Is it me drinking too much or ACH is to blame ?
(I have the summary of the incident on this post should you want to have a look a bit further detail)

Thanks !


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## sails (11 December 2008)

Perhaps this is one of the lesser known risks of covered calls.  If the ACH has rejected the stock as collateral, I expect they would then want to margin the sold call.

It would be a difficult situation where you can't close the position either.  I also see there is a notice today that there is planned legal action against OZL - so your call option might expire worthless anyway.

Have you checked the ASX option notices for information.  Here's one - http://www.asx.com.au/products/pdf/notices/2008/Clm22308.pdf and another dealing with implication of OZL options on expiry day if it is still in suspension: http://www.asx.com.au/products/pdf/notices/2008/Clm22708.pdf

Would pay to check regularly for notices from the ASX here: http://www.asx.com.au/products/futures_options/index.htm.  There are two sections under options on this page.

Hope it all works out OK for you


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## cuttlefish (11 December 2008)

It does seem pretty illogical though that OZL stock is not considered adequate collateral for a written OZL call.   If there's a good explanation I'd love to hear it.


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## alphaman (11 December 2008)

Yeah that seems rather silly. 

Do you know what will happen to the calls next Thursday if OZL remains suspended?


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## sails (11 December 2008)

cuttlefish said:


> It does seem pretty illogical though that OZL stock is not considered adequate collateral for a written OZL call.   If there's a good explanation I'd love to hear it.




Pretty much explained here: http://www.asx.com.au/products/pdf/notices/2008/Clm22308.pdf

I'm no expert on this, but it does appear that the ACH don't allow suspended securities to be used as collateral.  I didn't realise that either until now 




alphaman said:


> Yeah that seems rather silly.
> 
> Do you know what will happen to the calls next Thursday if OZL remains suspended?




All explained here: http://www.asx.com.au/products/pdf/notices/2008/Clm22708.pdf


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## alphaman (11 December 2008)

sails said:


> All explained here: http://www.asx.com.au/products/pdf/notices/2008/Clm22708.pdf



Do you know what it means? Because I'm not really sure.

My interpretation is that ACH will automatically exercise ITM options, using 55c, the last close as the reference price. This can lead to rather bizarre results.


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## xtanda (11 December 2008)

sails said:


> I'm no expert on this, but it does appear that the ACH don't allow suspended securities to be used as collateral.  I didn't realise that either until now




Yes, suspended material (since it's non liquid anymore), must be removed from collateral. For example: people doing naked put on BHP can lodge OZL security as collateral instead of  cash. On this kind of situation, of course this OZL frozen security is no longer elligible for collateral.

But I totally disagree if the same reasoning apply to covered call. For covered call there is no other better collateral than the stock it self, not even cash.
For example: let say on the day of expiry, the stock jump 100%. If you have OZL securities as collateral then ACH just simply hand in the stock to the option holder who will certainly exercise his right. But what happen if the collateral is cash, the option writer still need to hand in further cash to patch the gap (which in this case 100% in value).

The maximum the holder of the option can get is OZL security, so if the OZL security itself is not eligible then it's a joke...

ACH have all the reason to remove OZL security as collateral for all other type of collateral ,* except covered call*. I think this is reasonable.


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## cuttlefish (11 December 2008)

sails said:


> Pretty much explained here: http://www.asx.com.au/products/pdf/notices/2008/Clm22308.pdf
> 
> I'm no expert on this, but it does appear that the ACH don't allow suspended securities to be used as collateral.  I didn't realise that either until now




I can understand the mechanics of it, and I can understand why they won't accept suspended shares as collateral for other transactions, but it seems bizzarre not to allow stock to be lodged as collateral for a call option written over that very same stock.  

A gotcha I didn't know about that I'm glad to be now aware of.  

I wonder what other ones are lurking out there.


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## sails (11 December 2008)

alphaman said:


> Do you know what it means? Because I'm not really sure.
> 
> My interpretation is that ACH will automatically exercise ITM options, using 55c, the last close as the reference price. This can lead to rather bizarre results.




I'm not really sure either - but I think auto exercise is done by brokers, not the ACH.  Could be wrong...

It also looks like OZL options market will be open from 2pm on expiry day (18th Dec) and normal expiry processes will continue even if OZL is still in a trading halt.  Could be interesting to watch - I expect the MMs will have very wide spreads.


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## cuttlefish (11 December 2008)

alphaman said:


> Do you know what it means? Because I'm not really sure.
> 
> My interpretation is that ACH will automatically exercise ITM options, using 55c, the last close as the reference price. This can lead to rather bizarre results.




Thats my reading of it as well which also seems odd.  And what happens to holders of ITM puts - do they get auto exercised as well, and is the reference price used and are they just cash settled based on the reference price?  (since they can't source stock).

I'm assuming there wouldn't be many holders of ITM calls anyway.


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## sails (11 December 2008)

xtanda said:


> Yes, suspended material (since it's non liquid anymore), must be removed from collateral. For example: people doing naked put on BHP can lodge OZL security as collateral instead of  cash. On this kind of situation, of course this OZL frozen security is no longer elligible for collateral.
> 
> But I totally disagree if the same reasoning apply to covered call. For covered call there is no other better collateral than the stock it self, not even cash.
> For example: let say on the day of expiry, the stock jump 100%. If you have OZL securities as collateral then ACH just simply hand in the stock to the option holder who will certainly exercise his right. But what happen if the collateral is cash, the option writer still need to hand in further cash to patch the gap (which in this case 100% in value).
> ...




Yes, agree that it does seem unreasonable on the surface.  Perhaps there is more to it.  

At least you still own the shares, so if you were assigned on the calls, one would assume that your shares would fulfill your obligations and would close out your position entirely.  Might be a question for your broker so you know what you can and can't do before the 18th.

If you are not assigned, perhaps you could buy an ITM put between 2pm and 4pm on the 18th and then exercise it to close out your share position and put the money to better use elsewhere.  Something to consider perhaps, but definitely not advice as it may not fit into your trading plan and the MM spreads on the day may make that idea useless - just my 

Definitely talk to your broker to see what options you have.


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## cuttlefish (11 December 2008)

cuttlefish said:


> I'm assuming there wouldn't be many holders of ITM calls anyway.




Actually there were a few seriesi with 40, 50 and 60c strikes and there is a bit of open interest in them so there are holders of ITM calls.  So are these cash settled based on the reference price as well or do they end up holding suspended stock.  I'm assuming cash settled which means the writers have to front up the cash - if that is the case I think I'm starting to see why the OZL stock isn't suitable collateral for the call writers.

I guess with the price down where it is the margin lodgement requirement for cash collateral in place of scrip would be relatively small anyway.


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## sails (11 December 2008)

cuttlefish said:


> Thats my reading of it as well which also seems odd.  And what happens to holders of ITM puts - do they get auto exercised as well, and is the reference price used and are they just cash settled based on the reference price?  (since they can't source stock).
> 
> I'm assuming there wouldn't be many holders of ITM calls anyway.




If normal expiry processes happen as it states in the ASX document, it would appear that holders of ITM puts would be able exercise and effectively dispose of their shares.

If so, wouldn't be so good for put sellers.  Will check this out on Thursday and see if there are any option exercises on Friday morning.


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## sails (11 December 2008)

cuttlefish said:


> Actually there were a few seriesi with 40, 50 and 60c strikes and there is a bit of open interest in them so there are holders of ITM calls.  So are these cash settled based on the reference price as well or do they end up holding suspended stock.  I'm assuming cash settled which means the writers have to front up the cash - if that is the case I think I'm starting to see why the OZL stock isn't suitable collateral for the call writers.
> 
> I guess with the price down where it is the margin lodgement requirement for cash collateral in place of scrip would be relatively small anyway.




It looks like only the December series that are subject to normal expiry processes which wouldn't indicate cash settlement at this stage.  If OZL were to go completely belly up, then the ASX usually work on a cash settlement basis and often only on each expiry date.

Slightly off topic - but somewhat related: A question I have asked both brokers and the ASX, but no-one can tell me is that if I am in a long put calendar spread and the underlying goes bust and the ASX decide in their wisdom to cash settle options on the pre-determined expiry dates.  This would mean that I would be liable in cash for the front month puts and then have to wait a considerable time before receiving a cash payment for the long puts.  This could incur a large interest payment during that time.  My rule now is to always have a very cheap front month put that would not entirely limit the liability, but would reduce the problem. 

Suspension of the underlying and options can certainly cause some headaches


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## cuttlefish (11 December 2008)

Cheers sails. 

 I seem to recall reading a document once that had quite a lot of detail about what happens with options on expiry when the stock goes into suspension, but for the life of me I can't find it on the ASX site.  

 (Then again I think that I recall you provided quite a bit of information about this in another thread quite a while back, so maybe thats where I rember reading it  )


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## sails (11 December 2008)

cuttlefish said:


> Cheers sails.
> 
> I seem to recall reading a document once that had quite a lot of detail about what happens with options on expiry when the stock goes into suspension, but for the life of me I can't find it on the ASX site.
> 
> (Then again I think that I recall you provided quite a bit of information about this in another thread quite a while back, so maybe thats where I rember reading it  )




I think it was how Pasminco was handled.  It's in the ASX notices somewhere - perhaps do a search on Pasminco in ASX - or even here at ASF.  Would look it up, just a bit busy atm!


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## cuttlefish (11 December 2008)

I just did a search. I found the thread with the links to Pasminco but they are defunct - the documents must have been moved or removed from asx site.  (quick search on pasminco on asx produces nothing either).


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## sails (11 December 2008)

cuttlefish said:


> I just did a search. I found the thread with the links to Pasminco but they are defunct - the documents must have been moved or removed from asx site.  (quick search on pasminco on asx produces nothing either).




Here is one of them: http://www.asx.com.au/products/pdf/notices/2002/Clm02702.pdf

I started with the archives on this page: http://www.asx.com.au/products/options/notices/1999.htm and thenusing the "find on this page" function with IE (found under "Edit" on the tool bar) - typed in "pasminco".  You might be able to find the others that way 

PS - and another: http://www.asx.com.au/products/pdf/notices/2001/Clm16101.pdf


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## wayneL (11 December 2008)

Gee!

This should go into the option gotchas thread.


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## sails (12 December 2008)

wayneL said:


> Gee!
> 
> This should go into the option gotchas thread.




Yeah - it's a nasty one - will add a link to this thread.

Anyway, I had a look the course of sales of BNB the day after Nov expiry.  BNB went into suspension a few days earlier  which presumably is similar to the plight of OZL.  See course of sales below - only puts were exercised - most unpleasant for short put holders.  

If anyone has any of BNB November codes, we could look at the course of sales for the 27th November to get some idea of the trades going through and see if that gives any clues as to how OZL Dec options will fare should it still be in suspension next Thursday.


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## cuttlefish (12 December 2008)

I guess it makes sense that only puts were exercised - it seems unlikely anyone would want to exercise a call over a stock that is suspended and not likely to trade again in a hurry.   

For the put writers thats really part of the risk of a short position - effecitvely the equivalent of the stock price going to zero.  

I assume that anyone that exercised would still have to have delivered stock - which mean they'd have to organise a stock loan I assume if they didn't hold stock?

If trading was opened up there would have been plenty of stock holders prepared to pay a hefty premium to get a relatively immediate return on their holding (albeit meagre) as well as the benefit of locking in the capital loss by transferring the stock away. 

So opening the options for trading on the day of expiry provides an opportunity to allow the market to price the likelihood of the stock returning to the boards or not and at what price if it does.

Its really the autoexercise that is the main gotcha - something to be aware of for a long position holder.


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## alphaman (12 December 2008)

cuttlefish said:


> I assume that anyone that exercised would still have to have delivered stock - which mean they'd have to organise a stock loan I assume if they didn't hold stock?



Maybe that's why ASX opens the market for trading on the final day, so put holders without stocks can simply sell their puts to the market makers?


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## xtanda (12 December 2008)

The complication is that, if I want to get rid my stock, I just then write another ITM call, and it should be automatically exercised by the broker by the end of the day(otherwise I just write $0.01 call).. Then how the market 'value' the stock?

For example: if the reference price is $0.55, then theoretically $0.50 call can be sold for 55c or 50c (by intrinsic value restriction)...

What if the market just 'value' the stock at $0.4 for example, then the MM will price $0.50 call at very low number, then $0.40 call will be a bit higher...

But, if the market sell $0.40 call at 1c each, probably I take the change to buy some... once OZL announce they have successfully refinance, the price will shoot up. OZL is quite healthy company anyway (especially ZFX part who got plenty of cash)

I guess the option spread will be like:
strike price  bid   ask
$0.50 call   0.005  0.07
$0.40 call   0.001  0.17
$0.30 call   0.010  0.27

interesting to see....


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## sails (12 December 2008)

xtanda said:


> The complication is that, if I want to get rid my stock, I just then write another ITM call, and it should be automatically exercised by the broker by the end of the day(otherwise I just write $0.01 call).. Then how the market 'value' the stock?
> 
> For example: if the reference price is $0.55, then theoretically $0.50 call can be sold for 55c or 50c (by intrinsic value restriction)...
> 
> ...





To the best of my knowledge, an ITM option holder can request that their option is NOT auto exercised - may differ between brokers, I don't know.  So selling an ITM call may not guarantee exercise.  Interesting that only puts were exercised on BNB - no calls.

However, if you really want to sell your shares, to buy an ITM put keeps you in control as the long holder.  Agree, see what is offered on the day.

Anyway, it sounds like you may prefer to keep your shares as you sound confident about the company...


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## xtanda (12 December 2008)

mmm.. just have a chat with my broker about this 2 hour trading window, basically:

the trade is only to close out position (no new open position)
It will be 'normal' (not cash settled), so ITM call option will be exercised as normal but with delay settlement pending the resume of the trading of the stock

Hence, i cannot write new position or buy new option. (another strange policy ?)

So, the market will be only consist of holder of ITM call option that wants to cash in (and does not want to own the stock) as seller, and the ITM option writer that want to buy back his open call as buyer. 

It will be very interesting...


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## sails (12 December 2008)

Not an ideal situation at all.  Hopefully your calls are OTM and will expire worthless, xtanda.  Thanks for sharing this info and will have a peek at OZL options on Thursday afternoon.  Let us know how you get on!


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## sails (18 December 2008)

Just had a look at OZL options.  Only a few sellers sitting in the ask and only one trade in the calls at the time of writing.  This may change as there is still over an hour to go.

However, fair bit of activity on the put side.  The interesting thing is that the 40 put strike had some trades go through just after 2pm between 5c and 10c -even though 55c is the reference price for auto exercise.  That means they are technically 15c out of the money and should be expiring worthless.  

The 50 put strike has trades going through up to 15 - in fact a number of put strikes appear to be well overpriced 

Perhaps there are some scared put sellers who don't want to to take any risk of being "put" the stock and will pay more than normal to ensure they can get out.  Not unless the reference price has been lowered...


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## cuttlefish (18 December 2008)

sails its possible a lot of the put buyers will be stock holders wanting to offload the stock so they can clear their books and write off the holding.


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## sails (18 December 2008)

cuttlefish said:


> sails its possible a lot of the put buyers will be stock holders wanting to offload the stock so they can clear their books and write off the holding.




I think xtanda's broker said they couldn't open any new positions - they could only close positions today.  However, that's not mentioned in the ASX notice so it could be people buying puts to exercise later today.  Still, it's a large premium to pay at expiry!

EDIT: see xtanda's post #25


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## sails (18 December 2008)

You would have to think there were puts being bought to open today.  The 70c strike only had an open interest of 1019 and yet volume today ended up being 3048.  

Must have been heavy buying demand as some of those 70 strike puts were going through at 49c - that's 34c of extrinsic value.  

Would almost be worth being a seller of those options and effectively own the shares for 21c if you still believe it still has some life left in it!

How did you go today, Xtanda?

Took the snapshot below a few minutes before the options market closed - another 126 trades went through after this was taken.


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## sails (19 December 2008)

Below is a shapshot of the last few entries in the course of sales for OZL options exercised yesterday.  Interestingly put strikes as low as 30c were being exercised even though the autoexercise price was at 55c.  It is normally most unusual to have out of the money puts exercised. That would explain the apparently inflated put premiums yesterday.

Some calls were also exercised - some could have be due to auto exercise and not necessarily at the request of long call holders.


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## xtanda (21 December 2008)

I did manage to go online in the middle of company xmas party around 2pm...

unfortunately as advise before, I cannot open any new position.. cannot buy call , cannot sell call, cannot buy put ... my platform just give "Order Rejected - Stock Suspended".. I did not try to call the broker though as my option is still OTM...

I guess the one making money maybe only the market maker and some lucky one who did $0.4 call option. Why, all $0.4 call, $0.5c and $0.6c were sold at 10c around 2pm... so $0.4 writer who write ITM call can buy back the option very cheap.

But the latest development seems not very good for OZL as some lender walk out from refinancing talk and they have announce to close one mine in Tassie. My guess at the moment should the stock resume trading on 29 Dec, the investor will dump the share... maybe can go down as severe as $0.2.. Gee, I wish I have ITM call (hence autoexercise...) anyway... thanks for all your support...


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## sails (21 December 2008)

Thanks for the feedback, Xtanda.  

Sorry to hear you couldn't find a way to have your shares sold by exercise.  Perhaps it was a policy of your particular broker as I couldn't find any mention of not being able to open positions on the relevant ASX notice.  I guess it could be in one of their standing policies and re-iterated in their notices.

That said, it did appear that was some buying to open going on - the 70c put strike only had an open interest of 1019 and yet volume for that day was 3048.  That's 3 times as much volume vs. open interest.

If you are still stuck in it by Jan expiry, it might be worth checking with other brokers to see if they have the same policy.


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