How Does Risk Change in a Short Call Assignment?
How Does Risk Change in a Short Call Assignment?
A lot of traders that are new to options have to first deal with the number of moving parts in an option contract and all the permutations that fall from it. One of the first things that come to mind is when a call is assigned and becomes stock (this happened to one of our students yesterday). First, there is a call and now there is stock. What to do?
Remember is that there are two issues:
- Margin ñ What the clearing firm charges clients to hold the position?
- Risk- What is the potential loss or gain from the position?
Both of these, while related, are separate. Think of what happens when a call is assigned? Generally, the margin for a short stock position (50% of the market value + depending on the firm) drives up the cash needed to maintain the position. That freaks a new trader, who is not use to options, out . From a risk perspective, the risk actually declines and trader gets a couple of goodies.
- The conversion from a short call to short stock gives the position an imbedded put. There is very large potential (to 0 in the underlying anyway) downside gain from short stock that does not exist with the short call. That means the assignment process gives the short call holder a synthetic put.
- Any premium over parity (stock ñ strike price = parity) the short call position gets to keep. Options are assigned at parity on the closing print.
The risk before the assignment:
The risk after:
3. Note the upside risk for both positions is the same.
The problem of all this comes back to margin. If there is ample margin available (money in the account), there is no need to buy back the stock and close the rest of the position, since there is less actual risk. However, if the stock is hard to borrow, the time frame will be 3 trading days or depending on the policy/ availability of stock from the clearing firm.
If the trader wants out after assignement, the best way is to just close the short stock by buying it back (remember the rest of the position, spread, butterfly, etc) and then close any option position in the market that was a hedge. It is not pretty, but, overall, the net loss should never be more than commissions and bid/ask spread. It might even work out nicely.
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Mark Sebastian is the Director of Eduction for Option Pit, and a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. He is co-host of "Option Block," the wildly popular show on The Options Insider Radio Network.
He has been published in nationally on Yahoo Finance, quoted in the Wall Street Journal is a featured contributor for TheStreet.com. He also writes regularly for SFO, and OptionsZone, and is the managing editor for Expiring Monthly: The Option Traders Journal.
To learn more about Option Pit and its mentoring services, please visit OptionPit.com
Mark Sebastian is the Director of Eduction for Option Pit, and a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. He is co-host of "Option Block," the wildly popular show on The Options Insider Radio Network.
He has been published in nationally on Yahoo Finance, quoted in the Wall Street Journal is a featured contributor for TheStreet.com. He also writes regularly for SFO, and OptionsZone, and is the managing editor for Expiring Monthly: The Option Traders Journal.
To learn more about Option Pit and its mentoring services, please visit OptionPit.com
About Mark Sebastian
Mark Sebastian is a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. Along with his role directing the path of education for Option Pit, Mark is currently the director of risk for a private hedge fund. He writes a daily blog, the Option Pit blog, formerly Option911. Sebastian has been published nationally on Yahoo Finance, Google finance, Financial Times Alphaville and is a featured contributor for TheStreet.com. He is also published regularly at SFO, the Options Insider, and is one of the Co-Hosts of The Option Block Podcast, a featured Podcast from Options Insider Radio. Mark is the managing editor for Expiring Monthly: The Option Traders Journal. Sebastian has a Bachelor's in Science from Villanova University.
To learn more about Option Pit and their mentoring services, please visit: http://www.optionpit.com
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