Context
- I have no background in Finance but I have many years experience in investing in equities for my personal portfolio so I have a basic understanding
- I have never traded options
- I'm keen to understand and learn about options trading for some time before I try with real money (I'm mainly learning via youtube videos and TOS paper trading, which doesn't simulate assignments)
Example Scenario
GIVEN:
- I do not own any stock in the company that I am buying the options against
- I sell a single naked call at $150 (short)
- I buy a single naked call at $151 (long) for the same expiry date
- For this vertical spread I received a net credit of $50
- The stock price is $160 at expiry, with my call spread in the money
- I have less than $15,000 cash in my brokerage account
- I have less than $15,000 margin available
- I have no existing stock positions that the broker could liquidate
WHEN:
- My broker automatically assigns me on the short call and I am therefore required to sell 100 shares at $150
THEN:
- I would have to first buy 100 shares at $160 (at a cost of $16,000) in order to sell them.
- After selling the shares to fulfil my short call assignment, I will receive $15,000
- The outcome of the trade would be a loss: $50 credit received - (($10: $160 stock price - $150 short call strike price) * 100) - fees ≥ $950 loss
OR:
- I have the option (i.e. I could exercise my long option) to buy 100 shares at $151 (at a cost of $15,100), which would reduce my loss.
- After selling the shares to fulfil my short call assignment, I will receive $15,000
- The outcome of the trade would be a net profit: $50 credit received - (($1: $151 long call strike price - $150 short call strike price) * 100) - fees ≥ $50 loss
Obviously, the 2nd outcome is preferred.
Questions
- Is the broker going to allow me to make this trade given the risks?
- Would the broker allow me to exercise the long call, given I neither have the cash nor the margin, but I do have the impending income from the short call?
- Would the broker automatically exercise the long put on my behalf and then liquidate them to fulfil the short call assignment?