How do I do a “placeholder” trade when I get assigned early?
Getting assigned early on an option strike you have sold isn’t a big deal. Every trader experiences it because assignment can happen at any time and for any reason, rational or not.
Jim Fink won’t advise you to roll a trade until three weeks prior to expiration at the earliest because “early assignment” rarely occurs any earlier due to an option’s remaining time value. It is usually more profitable for an option owner to sell an option than to exercise it because exercising an option results in the forfeiture of whatever time value the option still possesses. In those rare occurrences, however, where an early assignment does occur more than three weeks prior to expiration, you would follow the steps below while waiting for Jim to issue his roll advice.
Let’s assume the original trade was an April put credit spread with the underlying stock trading above $50 and strike prices of $45/50. This begins as a neutral to bullish trade with both put strikes out-of-the-money.
If the stock price falls far below the short $50 put strike, the $50 put would lose most, if not all, of its time value. That makes it extremely vulnerable to early assignment since a put owner that wants to exit his long put position at that point will no longer have an incentive to sell the option and collect any remaining time value (because there isn’t any).
Of course, there is also always the possibility of an irrational early exercise even if the $50 put still possesses time value.
In any event:
1. Your broker should notify you in the morning pre-market open when the $50 short option you initially sold to open has been exercised early overnight and you are assigned and forced to buy 100 shares of the stock per option contract at $50 per share ($5,000 per contract). Remember, as long as you sell the assigned stock on the same trading day that you are notified of the early assignment, there is no increase in margin requirement and you do NOT need to come up with the $5,000 cash necessary to buy the 100 shares of stock. This one-day margin relief is called the “same-day substitution” rule.
2. When you sell the assigned stock at the current market price somewhere below $50, you will also want to sell the long $45 put option that you own to collect the value it likely has left. For example, you may be able to sell the stock for $44 and the $45 put for $1.75 for a combined credit of $45.75, which affects your bottom line the same as would closing out an intact 45/50 put spread for a 4.25 debit.
3. Sometimes you’ll do better selling the assigned stock and the long $45 put right away, and sometimes you’ll do better by waiting until later in the trading day…stock prices fluctuate and do so unpredictably. Whenever you decide to exit the assigned stock and remaining long $45 put, ALWAYS sell the assigned stock and the remaining long $45 put simultaneously so as to avoid detrimental time lag, which would occur if the underlying stock price moves lower between the time you sell the long $45 put and when you end up selling the assigned stock.
4. Because this was a bullish trade betting that the stock price would stay above $50, and because you presumably want to stay in the trade until Jim issues his roll advice, you will now want to buy an April call debit spread with strike prices of $45/50 (Buy to Open April $45 Call, and Sell to Open April $50 Call). Remember, call debit spreads and put credit spreads have identical risk/reward profiles at the same strike prices. By converting the original put spread into a call spread, you maintain identical exposure to the original trade objective while eliminating the risk of being assigned early again on a deep-in-the-money short put. Because early assignment on a put credit spread only occurs when the stock price has declined, this replacement call debit spread at the same $45/50 option strikes should be very cheap to buy since the stock price is presumably far below $50 now with only about a month remaining. The call debit spread is considered a “placeholder” position because its purpose is to remain identically exposed to the original trade objective without subjecting oneself to the immediate risk of another early assignment.
5. When Jim issues his roll advice, close out the April $45/50 call spread for a credit and open the later-dated option spread that Jim’s roll advice specifies in order to establish a new position that gives the trade more time to work out profitably.
Other actions you could take upon early assignment instead of buying a placeholder April $45/50 call debit spread:
1. Sell the assigned stock, continue to hold the long $45 put, and re-sell the $50 put. This recreates the original put spread position and maintains bullish exposure until OFI rolls, but your risk of getting assigned early again on the deep-in-the-money short $50 put is high)
2. Sell the assigned stock and sell the long $45 put. This closes out your position in the trade until OFI rolls, but your lack of continued exposure risks missing out on a stock rally before you re-enter the trade.
3. Hold the assigned stock and continue to hold the long $45 put. This maintains bullish exposure identical to owning a $45 call until OFI rolls, but ownership of 100 shares of stock has a much larger margin requirement than does one contract of a five-point option spread.