Option Question - OF

Posted by BrownBear on July 15, 2011 (05:37PM)

For a short call spread, lets say in the case of AAPL, I bought the $370 calls and sold the $365 calls.  Obviously it would be a ideal for both calls to expire worthless and just keep the premium.  But what if you do NOT buy the short calls back before expiration, and the stock closes at $365.03.  Does this mean I lose all the margin I put up for the trade?  Or will they just take the difference of the closing price and the short call? 

So if I had 5 contracts on this trade, will it cost me $2,500.00  (500 x (370-365)) ?

OR

will it cost me $15.00  (500 x (365.03 - 365))

I understand the mechanics that I upon assignment I am required to sell 500 shares at $365.00, but I'm unsure if brokers go out and buy the shares at current market price then sell, or if they would use the price of the OTM call that I bought.

If someone could help me out I would greatly appreciate it.

Posted by OldFart on July 15, 2011 (06:24PM)

BB - you are obligated to sell 500 AAPL shares @ $365. The 370 call expires worthless. Two possibilities

1. There is enough margin/cash in your account to support being short 500 AAPL shares. Monday after expiration there is a position in your account short 500 AAPL
2. Not enough margin/cash - somewhere on Friday before options expiration TK risk department closes your 5 short 365 calls at whatever the bid is at that time. The fee is $100.00 I believe

Posted by doougle on July 16, 2011 (10:55AM)

There are 3 possible outcomes, good, bad and worst.

Good:  AAPL sits at 364.99 or lower at expiration.  Your spread expires worthless (you keep the money)

Bad:  AAPL ends somewhere above 370 at expiration.  You receive 500 shares of Apple for 370 and instantly sell them for 365.  The margin withheld by the broker is to cover this difference in strikes.  This would be the max loss for the position.

Worst:  In this case, AAPL ends somewhere between your two strikes.  Now the 370 strike expires worthless, and your 365 strike is assigned. (You will be short the 500 shares at 365, as OF said).  500 shares of apple represents 182,000.00.  If you don't have that kind of cash sitting around in your account, you'll have a cruddy day untill you resolve it. (BTW, if you do have that kind of money sitting around, let's be friends)

In the first two scenarios, "good" and "bad", the position may win or loose, but it wont effect the rest of your account.  That's why I call the last scenario "worst".

Posted by TK All-Star on July 27, 2011 (09:19AM)

BrownBear: I saw your post about this AAPL spread and your questions re: expiration and assignment. My response got a little long for a simple forum reply, but I think you (and others) may find it a valuable read on spread trading and exercise/assignment specifically. In fact, I urge you to check it out - ignoring this information can have very expensive consequences. Take a look:


Let me know if you have any follow-up questions. Good trading to you!

Regards,

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