Calendar Diag Spread - Noob Questions

[russtak]

Hi All
Hypothetical trade
Buy 6 QQQQ Dec '10 $33.00 calls at $4.81
Sell 3 QQQQ May '09 $34.00 calls at $0.90

The underlying hit $34 last night and then retreated to close at $33.73.

1. Would I have been exercised even though the 3 short calls are about 2 weeks from expiry?
2. How would brokers handle the fact that I don't own the underlying shares ? Would they automatically exercise 3 of my ITM $33 calls and net off the difference?
tks R

 

[long88]

Hi All
Hypothetical trade
Buy 6 QQQQ Dec '10 $33.00 calls at $4.81
Sell 3 QQQQ May '09 $34.00 calls at $0.90

The underlying hit $34 last night and then retreated to close at $33.73.

1. Would I have been exercised even though the 3 short calls are about 2 weeks from expiry?
2. How would brokers handle the fact that I don't own the underlying shares ? Would they automatically exercise 3 of my ITM $33 calls and net off the difference?
tks R

russtak.

what you have there is a mix of diagonal spread and some long leap, not calendar.

with underlying hit 34, you wont get exercised, since there is still time limit left on your short options. options will be exercised when there is usually very little time limit left (deep ITM or stock is ex-dividend tomorrow, and your short is in the money)

if you got exercised, you will be left with short 300 stocks on your accounts, and if price keep going up, then your loss is getting bigger and bigger.

at some stage you have to buy back your shorts if price kept going against you, and this where you broker will give you a call (margin call) or they just close any other of your position to make the margin requirement within safe limit again.

so getting exercised is not so bad at all, but one thing here. it opens up your pocket to much more bigger losses, therefore you dont want that situation, as all long options are limited risk position.

 

[emilov]

watch the delta of your sold calls, if it gets near 0.9 they will exercise you early so you'll need to cover.

Cheers, Emil

 

[sails]

Russtak, I see your trade is hypothetical and good you are asking these questions before you go live! A few things to think about below:

...
1. Would I have been exercised even though the 3 short calls are about 2 weeks from expiry?

One simple guide to determine the possibility of being assigned is to work out if there is a reasonable amount extrinsic value in the option. (Extrinsic being the difference between the actual option price less any intrinsic value.) At-the-money (as in your case) and out-of-the-money options are made up of extrinsic value (some exceptions can apply for stocks about to go x-dividend). ATMs rarely get assigned due to the fact they have the highest extrinsic value.

While it's no guarantee that you won't be assigned if the option still has a reasonable extrinsic value, if it does happen, it is usually a gift as you can then buy to close the short stock position and then write another option and collect more premium – either from the same strike or you could choose a different strike.

Most unlikely that would happen, but very rarely a newbie will decide to exercise his long option with a fair bit of premium left. He doesn't realise it is better to simply sell that option to cash in on the remaining premium and just buy the shares he wants at market.

Also, if you were exercised, you still have your protective long calls which will protect you on the upside exactly as they were going to provide protection for your short call if it continues to go deeper ITM (in-the-money).

2. How would brokers handle the fact that I don't own the underlying shares ? Would they automatically exercise 3 of my ITM $33 calls and net off the difference?

Firstly, one of the worst things you can do is panic and exercise your long calls with so much extrinsic value as you would literally be giving away the premium you have paid for! If you want to close the position, make sure you sell your long calls rather than exercise.

If you were assigned and then wanted to completely close out the entire position, the ideal way is to enter a combo order that simultaneously closes the stock position and sells your long calls

What the broker will do really depends on how your broker handles assignment. If you do not have the funds in your account or don’t have the stock to deliver (as in your case), I believe IB give you about 10 minutes to deal with your assigned stock before they start randomly closing out positions – not a pleasant situation. Most option brokers give you most of the next day to deal with the assigned stock. Before you start live trading , please give your broker a call to find out exactly what their policy is on this and also what fees they charge for the stock transactions. If you are trading US options, it’s likely the fees won’t be an issue, but here in Oz assigned stock transaction fees can be deadly. I believe it is imperative to know these practical issues.

One other thing to be aware of is with short calls that are assigned, you end up with short stock IF you don’t already own the underlying shares as in your hypothetical trade. This means that funds come into your account together with the short stock. So you don’t actually owe cash with assigned short calls – you owe the stock instead. However, if short puts are assigned, you end up with long stock in your account and you either have to pay for them or sell them.

Hope this helps!

 

[russtak]

tks for that all

Nope Sails I have a long way to go so will not even contemplate trading hard earned for another year. Last few weeks been busy going through all guru posts from the last 5 years.
tks Russell