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I put on a debit weekly diagonal ITM put spread trade on stock A selling at $45 : I Buy back week put strike 55 sell front week put strike 50. I am assigned overnight and have to purchase 100 shares of Stock A for $50 ($5000 debit that creates a money due in my account). The next morning, my broker pre-empts me from exercising my put to sell the stock at $55, by selling the stock in my account for $42, creating a loss of $800. Is that legal ? The broker negated my spread trade!

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If you did not have the margin requirement (cash or marginable securities) to buy the stock then the broker had every right to liquidate your newly purchased long stock.

On face value, it's not a disaster unless after closing the stock position, the stock rose and you gave back paper gains on your long put.

What broker was this?

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  • Broker was Schwab. The spread trade was accepted - the long side was put on to limit any loss and guarantee a cash out of $500 if the front leg exercised. – Bill Collier Mar 10 at 3:39
  • I get it. Because the short put is at a lower strike, it's covered and once assigned, the downside risk is also covered. The only question mark is whether you had sufficient margin to carry it. Schwab isn't designed for traders nor is it their interest and I've read a lot of complaints about how they handle various issues like this as well as non options positions. I hope that their management of this didn't cost you. – Bob Baerker Mar 10 at 4:40
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Was $42 the fair market value of the stock when the broker sold it? If so, then you didn't really lose anything significant. At that point you were free to sell your long put in the market and end up about the same as if you had exercised it instead. Better, in fact, if there was any time value remaining. The broker certainly didn't cost you the difference between $42 and $55, because they left you still owning a long put worth at least $13.

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  • You have several incorrect assumptions. As long as both legs are deep ITM, underlying share price change is offset. The OCC handles exercise after the market closes and assignment notification occurs in the morning. The broker usually buys in positions in the pre market. Even if the OP got timely assignment notice, he'd have to be available to trade early in the AM as soon as notified. And there's also the market of the stock rising sharply before he can trade, causing his long $55 put to lose money. So it's possible that the broker could indeed cost some of the difference between $42 and $55. – Bob Baerker Jul 17 at 3:57
  • @BobBaerker If indeed the assigned stock is sold in premarket when options cannot be traded, you are right that risk is increased -- it could be favorable or unfavorable. However, I thought OP was concerned that the broker simply cost him the difference outright. OP didn't seem to be accounting for any value in the long put. – nanoman Jul 17 at 4:48
  • Forced buy-ins from assignment and short covering (and sell-outs) are done by the broker during after hours (pre and post). They're not going to work the trade for the best possible fill. They trade at the market which during after hours is wide, costing additional B/A spread. For illiquid stocks, that can be painful. Then on top of that, there's the market risk of a directional position which as you said, could be favorable or unfavorable. A good rule of thumb is that you never want your broker closing your positions. – Bob Baerker Jul 19 at 0:31

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