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Do you always get to keep the premiums for the options you've sold, regardless of whether they're exerised or not, provided they're held until expiration and not bought back? I thought this was the case, until I was reading W. Edward Olmstead's Options for the Beginner and Beyond and on page 103, he states that in a Deep in the Money Leaps Put Calender Spread, when the short option expires at the money it expires worthless, and the profit of the trade is the current value of the long option-the cost of the trade. I was under the impression in horizontal spreads, it's possible to keep both the premium for the short option and the long option it's sold against, and that regardless of what happened in any type of option trade you always got to keep the premium received for an option sold, but he seems to be implying otherwise here, or else he should have included the premium received for the short option in the profit calculation.
That's what I thought. So this is just an error on Olmstead's part, to not include the premium he receives from selling the option into the profit calculated with this sort of spread. It seems strage that a Professor of Applied Mathematics would make an error of this sort. From the OIC web site at:
http://www.optionseducation.org/getting_started/options_overview/what_is_an_option.html
As a seller, on the other hand, you begin with a net credit because you collect the premium. If the option is never exercised, you keep the money. If the option is exercised, you still get to keep the premium, but are obligated to buy or sell the underlying stock if you're assigned.
But aren't the premiums on in the money options so high, it would be very unlikely you would ever have to dip into your margin in a deep in the money diagonal spread? Seems like it's worth the slim chance of that happening. For example the May 19 SPY 125 call options have a value of over $10.49 today, and the June 16 126 calls have an ask price of 10.40, so you could open the trade for a credit, and even if the SPY ETF fell 7 points to $128.00 immediately after the short option was exercised at SPY's current market price, and before you could sell your long option, you would still have a profit of over $1000 from the sale of your short option, as well as several hundred from your long option, assuming you could sell that when the market price of SPY was 128.
Keeping option premiums you've sold
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Do you always get to keep the premiums for the options you've sold, regardless of whether they're exerised or not, provided they're held until expiration and not bought back? I thought this was the case, until I was reading W. Edward Olmstead's Options for the Beginner and Beyond and on page 103, he states that in a Deep in the Money Leaps Put Calender Spread, when the short option expires at the money it expires worthless, and the profit of the trade is the current value of the long option-the cost of the trade. I was under the impression in horizontal spreads, it's possible to keep both the premium for the short option and the long option it's sold against, and that regardless of what happened in any type of option trade you always got to keep the premium received for an option sold, but he seems to be implying otherwise here, or else he should have included the premium received for the short option in the profit calculation.
Once you sell an option, the premium is yours....forever. If you buy the option back, the premium you pay for it, is gone....forever. If an option you sold expires worthless, there is no further obligation to you. If it is exercised, you must surrender shares if it was a call, or buy at the strike price, if it was a put. If it is a complex, strategy, you can treat each leg as indicated above.
That's what I thought. So this is just an error on Olmstead's part, to not include the premium he receives from selling the option into the profit calculated with this sort of spread. It seems strage that a Professor of Applied Mathematics would make an error of this sort. From the OIC web site at:
http://www.optionseducation.org/getting_started/options_overview/what_is_an_option.html
As a seller, on the other hand, you begin with a net credit because you collect the premium. If the option is never exercised, you keep the money. If the option is exercised, you still get to keep the premium, but are obligated to buy or sell the underlying stock if you're assigned.
I tried to open your link but it didn't load. However, the last paragraph is in agreement with what I said, i.e., the "net credit" is the premium.
For some reason this thread reminds of a teeter-totter.
You'll notice when you sell a credit spread or cash secured put, the TK order screen shows that whatever credit you bring in is subtracted from to total margin requirement. It will say "Funds Required for Trade" (or something like that).
Although what you say is technically true, to make a
trade on the basis that the premium received will keep you from dipping into
your margin, should indicate to you that maybe you are taking more risk than
you want. Having some cushion is often what allows you to whether a correction
without that sinking feeling and the compulsion of selling something just to raise
cash.
But aren't the premiums on in the money options so high, it would be very unlikely you would ever have to dip into your margin in a deep in the money diagonal spread? Seems like it's worth the slim chance of that happening. For example the May 19 SPY 125 call options have a value of over $10.49 today, and the June 16 126 calls have an ask price of 10.40, so you could open the trade for a credit, and even if the SPY ETF fell 7 points to $128.00 immediately after the short option was exercised at SPY's current market price, and before you could sell your long option, you would still have a profit of over $1000 from the sale of your short option, as well as several hundred from your long option, assuming you could sell that when the market price of SPY was 128.
The trade you describe:
Sell SPY May 125 Call @ -10.49
+
Buy SPY June 126 Call @ 10.40
+
Margin = 1.00 (your short call is 1.00 lower than the long)
=
Total Cost: (1.00 - .09 = .91 x 100) = 91.00 per contract + commission
There are two things I should point out.
You would be selling an in the money option with 5 days till expiration. There would be moderate early assignment risk, increasing to high risk as the week goes by.
The second thing is that if this trade goes against you, it could go against you fast. The Position Delta is 181.00 per contract (according to the P+L Calc) and the Gamma will grow rapidly as the week goes on. That means the price will whip around.
It's an interesting looking trade. I'd be sure I understand why the May IV is 22 and the June IV is 18. I'd make this trade small a couple times, and then ramp up if you still like it.
I evaluated a trade earlier today that seemed juicy, but then I realized there would be serious dividend risk. And an early assignment on that position would create a dilemma similar to the one mentioned in this forum post. So I decided against it.
Sell SPY May 125 Call @ -10.49
+
Buy SPY June 126 Call @ 10.40
+
Margin = 1.00 (your short call is 1.00 lower than the long)
=
Total Cost: (1.00 - .09 = .91 x 100) = 91.00 per contract + commission
There are two things I should point out.
You would be selling an in the money option with 5 days till expiration. There would be moderate early assignment risk, increasing to high risk as the week goes by.
The second thing is that if this trade goes against you, it could go against you fast. The Position Delta is 181.00 per contract (according to the P+L Calc) and the Gamma will grow rapidly as the week goes on. That means the price will whip around.
It's an interesting looking trade. I'd be sure I understand why the May IV is 22 and the June IV is 18. I'd make this trade small a couple times, and then ramp up if you still like it.
I evaluated a trade earlier today that seemed juicy, but then I realized there would be serious dividend risk. And an early assignment on that position would create a dilemma similar to the one mentioned in this forum post. So I decided against it.
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