Options question about assignment at expiry with spreads

[cuttlefish]

Just trying to understand some of the mechanics of assignment on expiry in the situation of an open put spread.

If I have an open short put and an open long put on expiry day.

And someone assigns against my short put (as I understand it they can do this until 7pm on expiry day? Is this correct?)

As I understand it I wouldn't get notified of the assignment until the next day.

This would mean I wouldn't be able to assign against my long put to cover (or partly cover) the assignment against my short put - is this correct?


I know that academically this situation is unlikely to arise for a large variety of reasons but just curious as to what the mechanics would be if it did.

 

[sails]

Just trying to understand some of the mechanics of assignment on expiry in the situation of an open put spread.

If I have an open short put and an open long put on expiry day.

And someone assigns against my short put (as I understand it they can do this until 7pm on expiry day? Is this correct?)

Yes Cuttlefish, this is correct. However, most (if not all) ITM short options are exercised on expiry day - very rare not to happen due to most brokers automatically exercising all open ITM options (even long options) on expiry day. Pays to know your brokers policy and how much ITM triggers auto exercise on expiry day.

As I understand it I wouldn't get notified of the assignment until the next day.

This would mean I wouldn't be able to assign against my long put to cover (or partly cover) the assignment against my short put - is this correct?

Yes - and a good reason to ensure that the short option or entire spread (if any remaining value left in your covering option) is closed before expiry. I'm guessing you are referring to credit spreads, however, if it is a debit spread, both legs would then be ITM and exercise would effectively close both out.

The other danger is that you don't just receive notification - you actually find you are long stock in your account on the next trading day (unless you are with IB only to possibly find they have liquidated randomly (not necessarily your covering long) potentially leaving a huge mess ).

Once you are long stock you no longer have a limited risk trade. It is now trading with a delta of 1 and not a pretty picture if the market is down heavily on that next day!

If you are in a put credit spread - it depends where the stock closes on expiry day. Most (if not all) short options that are ITM are assigned on expiry day - so it pays to close them out unless the long is also ITM to exercise.

Eg. If the stock closes half way between your short and long, it pays to simply close out the short before the market closes. If there is any value left in the long, simply close the entire spread.

The other tricky thing to watch is if the stock closes right on your short strike. You might think you are safe by 1c or so, but the long put holder still has the right to exercise for whatever reason. I have seen some exercised that have been slightly OTM - so no guarantees!

Handling options at expiry tends to be glossed over by most option educators (at least that's been my experience) - and yet it there are some pretty heavy risks if it's not handled correctly!

Hope this helps!

 

[dubiousinfo]

Another trap to be aware of is dividend ex dates. This can result in even OTM calls being exercised depending on the size of the dividend. I found this one out the hard way.

 

[wayneL]

Another trap to be aware of is dividend ex dates. This can result in even OTM calls being exercised depending on the size of the dividend. I found this one out the hard way.

Or when stock cost of carry exceeds extrinsic value in ITM short puts, you may be assigned before expiry.

 

[cuttlefish]

Thanks for the detailed reply sails - it could make for some nervous situations in a volatile market.

I remember one of the options books warning not to assume that assignment won't occur just because its before expiry or options are out of the money - i.e. to expect the unexpected - sounds like it was good advice based on all of the comments above.

What sparked the thought was NAB releasing news today that caused a 13% tumble - I'm assuming that had that been released at 4:30 p.m. yesterday there would have been a few additional assignments before 7 p.m.

 

[sails]

Thanks for the detailed reply sails - it could make for some nervous situations in a volatile market.

I remember one of the options books warning not to assume that assignment won't occur just because its before expiry or options are out of the money - i.e. to expect the unexpected - sounds like it was good advice based on all of the comments above.

What sparked the thought was NAB releasing news today that caused a 13% tumble - I'm assuming that had that been released at 4:30 p.m. yesterday there would have been a few additional assignments before 7 p.m.

Yep - I've seen some nasty surprises for option sellers on expiry day. One was a take-over announcement on expiry day - my memory it was WMC. OTM short call sellers thought they were safe - only to find they were exercised with short stock in their accounts the next day - ouch!

Another that I remember was RIO with much better than expected earnings release about 10 minutes after the market closed on expiry day. Once again, what was supposed to have been safely expiring short calls ...

Assignment is not always a bad thing - but as I predominantly work with spreads, it is something I prepare for in my trading plan.