Got a long or short spread that is near expiration and/or completely in-the-money (ITM) and need to get out? If this sounds like a position that you have and the platform is giving you an error, such as "order price is greater than the spread width," like the example below, then continue reading.
Don’t have time to read the explanation below? The short answer to get out of an ITM spread is to enter the order at the width price. Using the $10-wide short call spread example above, you may start at $10.00, instead of $10.10, and penny up to a nickel ($0.05) above the spread width. If you’re curious and want to learn more, then continue reading below.
The platform marks positions at the mid-price. That said, you may notice that the platform may reject your order if the mid-price is greater than your spread width, as pictured above. Generally speaking, the bid-ask spread for options that are ITM widen. Why does this happen? Because market makers are compensating for the risk associated with taking the other side of an ITM option. ITM options have an immediate risk due to the intrinsic value, especially towards expiration.
For example, if you have a $5 wide short put spread that is ITM then your max loss, or risk, is credit received minus $500. The platform may mark a mid-price at $5.40 debit due to the wide bid-ask spread we talked about. Entering a closing price at the mid of $5.40 will most likely cause your order to be rejected, as reflected in the example above. So what gives? In a nutshell, the platform is preventing you from losing more than your max loss.
So how do you close an ITM spread then?
- ITM credit (short) spreads - buy it back at the spread width
- Example: start by entering a $5.00 debit for a $5 wide ITM short call/put spread. If
- ITM debit (long) spreads - sell it at the spread width
- Example: an ITM $3 wide long call/put spread can be closed out at $3.00 credit.
If you’re having trouble closing an ITM spread at the price of the spread width then you can consider increasing any debit price by a penny or decreasing by a penny below when selling for a credit. For example, buying back a $5 wide short spread for $5.01 debit or selling a $3 wide long spread at $2.99 credit.
Since we do not charge a closing commission you can save yourself from spreads that are ITM by closing them out before they expire and save yourself the $5/leg exercise and assignment fee. Before taking this route, please consider your quantity. Let’s say you have a 5-lot short put spread and you end up paying a $5.05 debit to close. In this case, you’d be overpaying by $15 because paying $0.05 cents over the spread for the spread equals $25 ($5 x 5 qty = $25) when the exercise and assignment fee is only $5/leg, or $10 total for exercise and assignment fees on a spread.
If you’re wondering what happens to a spread that expires ITM then please click here.