To exercise or not to exercise - that is the question. We’re not talking about working on your summer bod’. Today, we’re talking about exercising long options. More specifically, the scenario we are going to explore is one in which the short leg of your defined-risk spread gets assigned and you’re stuck with the resulting position along with the long leg. But first, let’s review what happens when your short call or put gets assigned.
Assigned Calls = Short Stock
Assigned Puts = Long Stock
If you are assigned early on one of your short option positions, then you may be asking yourself: what now? How do I manage this early assignment? Well, there are three situations you may find yourself in:
Account can handle the assignment
If your account can handle the assignment and you want to be long or short the stock, you may choose to hold on to the stock position if that suits you.
*Please note: IRA accounts cannot maintain short stock positions. A short stock position is considered a Restricted Strategy. The short stock position MUST be met by closing the short stock (buying it back) before market close of the day the short stock was assigned.
Account cannot handle the assignment and now you’re in a margin call
If your account cannot maintain the position (i.e you ended up in a margin call and have negative buying power), then you will need to manage it. Naturally, you may gravitate towards an exercise request, but you could be leaving money on the table because your long option may have some residual extrinsic value. That said, performing a covered stock order could help with reducing your overall max loss. Continue to Option #3 below to learn more.
Close out of your assignment with the long option leg (covered stock position)
If you're a visual person, then we made a video about creating a covered stock order. To view, please click here. A covered stock order is an order to buy or sell stock and sell your long ITM option(s) simultaneously in the same order. This is typically the most beneficial management method, as you’ll be taking advantage of any extrinsic value that may be built into the long ITM leg. Additionally, if you are experiencing a margin call due to assignment then performing a covered stock order may help you meet your margin call.
More importantly, we do not charge commissions on closing orders. There is a $5 charge per exercise request (regardless of quantity). As long as you can place the covered stock order at a price that is more beneficial than the exercise, you should come out ahead compared to the exercise. Also, if you're in a margin call and have negative options buying power, then the call will be met when the covered stock order fills, and return to positive options buying power.
Examples for a 1-Lot vertical (defined-risk spread):
Short Call Vertical
Assigned on short call on short call vertical spread:
XYZ Stock trading @ $160
Portfolio Position: 1 (1-lot) XYZ short call vertical spread: -150 (short) /155 (long). This is a bearish trade since you want the price of XYZ stock to stay below the short strike of $150.
You get assigned on the short -150 call = 100 short shares of XYZ @ $150. Portfolio still holds the long 155 call.
As long as you can buy those shares back and sell the long 155 call for a debit of $155.04 or less, you will be coming out a little ahead due to the exercise cost of $5. The reason why the price of the covered stock position should be equal to the price of your long call strike is the intrinsic value that is now built into the long call.
Short Put Vertical
Assigned on short put on short put vertical spread:
XYZ Stock trading @ $140
Portfolio Position: 1 (1-lot) XYZ short put vertical spread: -150 (short) /145 (long). This is a bullish trade because you want the price of XYZ to stay above $150.
You get assigned on the short -150 put = 100 long shares @ $150. Portfolio still holds the long 145 put.
As long as you can sell those shares and sell the long 150 put for a credit of at least $144.96 or more, you will be coming out a little ahead due to the exercise cost of $5. The reason why the price of the covered stock position should be equal to the price of your long put strike is the intrinsic value that is now built into the long put.