What to do if you are assigned early.
music selection: “Lady” — Lionel Ritchie
I have previously promoted the idea of using net debit spreads in the current market environment. I have been buying three spreads per week, one bearish, one bullish, and one market neutral in an attempt to profit no matter what the markets do. These spreads combine the leverage of long options, with the income of short options to play both ends against the middle. The result is a high probability win scenario where returns are often over 100% annualized.
I have been getting multiple confused emails however. The Lizard Army is concerned about blowing up their account in the event they are assigned early on the short legs of their spreads. I’m going to start by dispelling the notion that there is a great deal of risk in that scenario. In the event of early assignment, your position is automatically fully hedged. You won’t experience a sudden explosion in margin requirement or a margin call. And you will actually earn a little more than the ordinary maximum return on the spread because you collect some unexpired time value on the short option.
Early assignment on the Bull Call Spread will result in short calls being assigned. You will have a short position in the underlying shares and offsetting in the money long calls. To clean this little scenario up, open a COMBO ORDER. You want to sell to close the long calls while simultaneously buying to close the short shares. Do this for how many ever contracts were assigned and the corresponding amount of shares in 100 share increments. Most brokers have a utility that will do this easily and intuitively. If the maximum value of your spread was 1.00 at expiry and you had 10 cents of time value left on the short call, you can expect to collect about 1.10 in total value on the spread for a bonus gain.
Early assignment on the Bear Put Spread will result in short puts being assigned. You will have a long position in the underlying shares and offsetting in the money long puts. To resolve this, open a COMBO ORDER. You want to sell the long puts while simultaneously selling the long shares. Do this for however many contracts were assigned and the corresponding shares in 100 share increments. Your broker will probably have an automated utility to structure that trade. Like with the BCS, any time value left on short put at time of assignment is bonus income to you.
Early assignment on the Calendar Spread can result in early short calls or short puts being exercised depending on whether you used calls or puts to build the spread. I like puts because I prefer to be early assigned long rather than short in the unlikely event it happens. In the event your short put is assigned, you will have long shares and an offsetting hedge of long puts. Close this the same way you closed the Bear Put Spread above. Alternatively, if you had a call based Calendar, use the method above for the Bull Call Spread to close. In all cases, always use a combo order to get the best fill price and most efficient commission pricing. I find the best commission pricing on options is at Interactive Brokers.
I hope this article puts nervous raptors at ease by making it clear that 1) their positions will be fully hedged and not result in outlandish risk 2) it is relatively simple to close out a position that has been assigned early. Have you bought net debit spreads after reading an article on the Raptor? Have you been assigned early? Speak up in the comments section!
Devour your prey raptors!