All, I'd like to share a few trading insights for short (credit) vertical spreads. The central point is if you're trying to close the position shortly before expiration and the long option is way OTM, consider not trying to sell it if your objective is to get filled now. No one will want to buy that way OTM option minutes before expiration, and entering that leg of the order may impact your execution, and profits.
JP Morgan was releasing earnings Friday pre-market. It closed the day before (Thursday 1/12) at $36.85. I wanted to play an iron condor
Sell $36 put and buy $35 to cover
Sell $37 call and buy $38 call to cover
All options expired at market close on Friday. I received a credit (up front payment) of $0.46 per condor, and I sold 40 of these. My maximum loss was 1-0.46 = 0.54 per condor. My goal was for all contracts to expire worthless, so I would keep the entire $0.46 credit. For this to happen, JPM had to close the next day in between $36 and $37.
With the mediocre earnings, outlook, and pending downgrades in Europe, JPM gapped down the next morning. (Gaps, by the way, are the worst--unless its in your favor! Not here however.) I saw a print of $35.22 at one point, it might have been lower at some point. At the low point, I could have closed my position for maybe a $0.20 loss, per contract.
One point about trade allocation. Never, ever put all your capital in one trade. If I had put 100% of my capital into this one trade, I would (should?) have panicked and taken my loss before the trade lost its maximum. But since I was risking about 3% of assets, I decided to hang on.
The end of the day comes around, and JPM recovers to about $35.70-$35.90. Here's a point if you're used to trading index options: ITM options (long or short) mean exchange of stocks, not cash! If I was playing the S&P 500 SPX index options, I probably would have held to expiration because the gains/losses are settled in cash. (Don't try that at home.) But if the 40x $36 put options I had sold were in the money by $0.01, I would be on the hook to buy 4,000 shares of JPM at $36. Let's suppose I'm interested in JPM (I wasn't), and let's suppose I had cash to buy 4,000 shares of JPM at $36 (I didn't), what if I was put those shares and JPM gapped down to $35 on Tuesday? Remember, equity options settle in stock, not cash.
To zero in on the scenario, I was short 40x $36 puts and long 40x $35 puts. All contracts would expire in minutes and settle at JPM's closing price (eventually $35.92, but no one knew that.) Unlike SPX scenarios, I knew I wanted out, now. (I ignored the $37-$38 wing of the iron condor because there was just 10 minutes left, but don't forget to think about those.) I wanted to buy back the $36 puts and sell off the $35 puts. I entered the order with 8-10 minutes left, JPM was trading around $35.90, and to ensure near immediate execution I entered a market order. Note that market orders are rarely a good idea for options, but this situation is unique. The width of the bid/ask spread was about $0.03, however, the actual spread was fluctuating with the price of the underlying. This market order should execute quickly, right?
I didn't get filled for many many minutes. It turned out OK--about 50% profit on margin for a day trade, can't complain at all--but I now think my order was delayed because I was trying to sell 40x $35 puts. Who would want to buy $35 puts with less than ten minutes left when the underlying was trading at $35.90, and the market wasn't melting down? In fact I sold 10 of the 40 long contracts for $0.01 each.
The morals of the story:
1. Realize that equity options settle in stocks, not cash. If you don't want a long/short position in the stock over the weekend, you must close the position. No ifs, ands, or buts about it.
2. Watch your trade allocation. If you put too much money in one trade and the trade goes against you, you will (and should) panic. However half the time, if the fundamentals are ok, the market retraces. If you have put money you can afford to lose into that trade, you can consider taking the risk waiting for that retracement.
3. Despite my bad habits with SPX, really really don't try to squeeze every last penny out of your short options if they are near the money. As your short options approach expiration, there is essentially no time value left, and they are fluctuating nearly one for one with the underlying. Do you really want to squeeze that last dime, taking the risk that the short option can be worth many dimes or dollars at expiration? Buy those short options back. Just do it, don't argue. A late week SPX move (last ten minutes) has saved several trades, but I have been singed too.
4. If your short contracts are profitable, and if you are wisely trying to close a short equity spread position very near expiration, consider using a market order. For equity options on large stocks, the width of the spread isn't the enemy. Its the wild fluctuation of the underlying. Pick your moment, and place that order.
5. If your short contracts are profitable, and if you are wisely trying to close a short equity spread position very near expiration, consider not trying to sell off the covering long leg. I cannot say for sure, but it could delay your order, and its the short leg that you really want to close, and close now.
I hope this story helps someone. Safe trading.