Since many of you are still running up to ten deep in the money options spreads, it’s time to review how to handle options called away.
The higher the yield on a security, the greater the call away risk. With ten year US Treasury yields now at 4.00% the call away risk is heightened.
Let’s say you call away an option the day before the ETF goes ex dividend. That enables you to collect an entire quarter’s 88 basis point payout in a day. A measly 88 basis points may not be much for you, but it is a lot for a highly leveraged hedge fund.
Our next options expiration is Friday, April 21 in 10 trading days.
In the run-up to every options expiration, which is the third Friday of every month, there is a possibility that any short options positions you have may get assigned or called away.
The first notice you may get of options called away is a shocking out-of-the-blue margin call of $1 million or more.
If that happens, there is only one thing to do: fall down on your knees and thank your lucky stars. You have just made the maximum possible profit for your position instantly.
Most of you have short option positions, although you may not realize it. For when you buy an in-the-money vertical option spread, it contains two elements: a long option and a short option.
The short options, which are owned by somebody else, can get “assigned,” or “called away” at any time, as it is owned by a third party, the one you initially sold the put option to when you initiated the position.
You have to be careful here because the inexperienced can blow their newfound windfall if they take the wrong action, so here’s how to handle it correctly. I’ll use a recent trade as an example.
Let’s say you get an email from your broker telling you that your call options have been assigned away. I’ll use the example of the Tesla (TSLA) December 2022 $140-$150 in-the-money vertical BULL CALL spread.
For what the broker had done in effect is allow you to get out of your call spread position at the maximum profit point 9 days before the December 16 expiration date. In other words, what you bought for $8.80 two weeks ago is now $10.00!
All you have to do is call your broker and instruct them to exercise your long position in your (TSLA) December 2022 $140 calls to close out your short position in the (TSLA) December 2022 $150 calls.
This is a perfectly hedged position, with both options having the same expiration date, the same amount of contracts in the same stock, so there is no risk. The name, number of shares, and number of contracts are all identical, so you have no exposure at all.
Calls are a right to buy shares at a fixed price before a fixed date, and one option contract is exercisable into 100 shares.
To say it another way, you bought the (TSLA) at $140 and sold it at $150, paid $8.80 for the right to do so, so your profit is $1.20, or ($1.20 X 100 shares X 12 contracts) = $1,440. Not bad for a 9-day limited risk play.
Sounds like a good trade to me.
Weird stuff like this happens in the run-up to options expirations like we have coming.
A call owner may need to buy a long (TSLA) position after the stock market close, and exercising his long December $140 call is the only way to execute it.
Adequate shares may not be available in the market, or maybe a limit order didn’t get done by the market close.
There are also thousands of algorithms out there that may arrive at some twisted logic that the puts need to be exercised.
Many require a rebalancing of hedges at the close every day which can be achieved through option exercises.
And yes, options even get exercised by accident. There are still a few humans left in this market to blow it by writing shoddy algorithms.
And here’s another possible outcome in this process.
Your broker will call you to notify you of an option called away, and then give you the wrong advice on what to do about it. They’ll tell you to take delivery of your long stock and then post additional margin to cover the risk.
Either that or you can just sell your shares on the following Monday and take on a ton of risk over the weekend. This generates a boatload of commission for the brokers but impoverishes you.
There may not even be an evil motive behind the bad advice. Brokers are not investing a lot in training staff these days because as soon as someone learns something useful, they take a job elsewhere for more money. It doesn’t pay. In fact, I think I’m the last one they really did train.
Avarice could have been an explanation here but I think stupidity and poor training and low wages are much more likely.
Brokers have so many legal ways to steal money that they don’t need to resort to the illegal kind.
This exercise process is now fully automated at most brokers but it never hurts to follow up with a phone call if you get an exercise notice. Mistakes do happen.
Some may also send you a link to a video of what to do about all this.
If any of you are the slightest bit worried or confused by all of this, come out of your position RIGHT NOW at a small profit! You should never be worried or confused about any position tying up YOUR money.
Professionals do these things all day long and exercises become second nature, just another cost of doing business.
If you do this long enough, eventually you get hit. I bet you don’t.
Calling All Options!
