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Can someone please explain something about the option spreads? How come this broker is not exercising these short options in this video as they are deep in the money?

https://www.youtube.com/watch?v=0djdzr4Jsh0

I took a class where they warned that once your short position is in the money always be afraid of it getting exercised anytime. If you don't have a big enough account to cover the assigned shares you could lose a lot of money. So they said to consider closing the short position once it's in the money. It stuck in my mind and once my short call or put is in the money I always exit the trade even if it's a loss.

I know that there are still 4 days left for the expiration in these trades that John Carter is doing but still this could be millions of dollars of assignment, if it happens. Obviously if the broker or the trader on the other side is going to lose money then they won't exercise. Is there a clear formula or calculation I need to perform to see if an assignment will happen or not, the only ones I know for sure is the expiration or dividend day.

Thanks John

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  • Welcome to Money.SE. Please summarize, in words, exactly what you want members to understand by watching the video. Assume that, for whatever reason, the video is no longer available. If that's the case, your question might not be clear enough for a decent answer.
    – JTP - Apologise to Monica ♦
    Aug 22, 2021 at 12:15

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American options may be exercised early if:

  • They are ITM and the bid trades at a discount to the intrinsic value (a long option owner sells at that price). The buyer does a discount arbitrage and someone gets assigned.

  • There is a pending dividend which offers an arbitrage

So if a deep in the money option has time premium remaining, it makes no sense to exercise it since you would be throwing away the time premium by doing so. The exception to this would be if your closing commission costs exceed that time premium.

As long as you own the long leg, you can't lose more than the spread's maximum risk. Where you can lose a lot of money is if the short option is ITM at expiration, the long leg expires and then you have large directional equity risk on the next trading day.

How early exercise is handled depends on the broker. If exercised early and you don't have the cash and/or marginable securities to support the position, your broker will close the equity position and you likely have an account violation. You don't want your broker doing this because it often occurs in the after market when prices are unfavorable. If both legs are ITM, they'll exercise both legs.

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  • Have you seen this video? my questions really revolves around it that why these shares are not assigned with short option in the money. Thanks
    – JohnZee
    Aug 22, 2021 at 0:39
  • No, I didn't watch the video. I explained why short options are exercised early Now I watched it. Do you realize that this is a long 1700/1800 call vertical so if the short 1800's are exercised, you make money?
    – Bob Baerker
    Aug 22, 2021 at 1:28
  • Thank you, I guess that's the part I didn't understand. So as long as an option seller would make money, the short options would not be assigned. I was more worried about how an account would handle assignment of millions of dollars of TSLA shares. Thanks again for sharing your knowledge.
    – JohnZee
    Aug 22, 2021 at 10:43
  • Not exactly. If TSLA goes above $1800, your short $1800 call could be assigned at some point. But you own the $1700 call which should be worth at least 100 points more (give or take the B/A spread and/or time premium remaining, if any).
    – Bob Baerker
    Sep 21, 2021 at 2:32

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