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I have an account with ShareBuilder and recently purchased some call options, which ended up deep ITM (in the money). I attempted to close the options too close to when the market was about to close (but the order was issued); however, ShareBuilder has automatically exercised the options for me since the Market Order to close the options did not go through. Since I did not have the cash, I now have a negative cash balance. What are the choices available to me at this point?

Can I sell the stocks that were purchased from the options come the next trading day to address the negative cash balance that resulted from the automatic exercise? Will this be in violation of Regulation T?

Unfortunately, without selling the stocks that were exercised from the options, I feel that my only other alternative would be to funnel money from various places into my ShareBuilder account, and liquidate most of my other stocks.

Update

ShareBuilder allowed me to sell the stocks that were purchased from the automatic exercise, but my account is now "restricted" -- I can only trade with "settled" funds. The support person I spoke to also explained that if this happens too often (without clarification on what's considered often), then I will lose my privilege to trade options. Had I not sold the stocks immediately, a broker would have logged into my account, and liquidated stocks not limited to the ones that were purchased from the options.

  • After you finish this learning experience, have the automatic settlement feature shut for your account, and don't wait until the last moment to settle. – Optionparty Feb 4 '14 at 16:27
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Automatic exercisions can be extremely risky, and the closer to the money the options are, the riskier their exercisions are.

It is unlikely that the entire account has negative equity since a responsible broker would forcibly close all positions and pursue the holder for the balance of the debt to reduce solvency risk. Since the broker has automatically exercised a near the money option, it's solvency policy is already risky.

Regardless of whether there is negative equity or simply a liability, the least risky course of action is to sell enough of the underlying to satisfy the loan by closing all other positions if necessary as soon as possible.

If there is a negative equity after trying to satisfy the loan, the account will need to be funded for the balance of the loan to pay for purchases of the underlying to fully satisfy the loan.

Since the underlying can move in such a way to cause this loan to increase, the account should also be funded as soon as possible if necessary.


Accounts after exercise

For deep in the money exercised options, a call turns into a long underlying on margin while a put turns into a short underlying.

The next decision should be based upon risk and position selection. First, if the position is no longer attractive, it should be closed. Since it's deep in the money, simply closing out the exposure to the underlying should extinguish the liability as cash is not marginable, so the cash received from the closing out of the position will repay any margin debt.

If the position in the underlying is still attractive then the liability should be managed according to one's liability policy and of course to margin limits.

In a margin account, closing the underlying positions on the same day as the exercise will only be considered a day trade. If the positions are closed on any business day after the exercision, there will be no penalty or restriction.


Cash option accounts

While this is possible, many brokers force an upgrade to a margin account, and the ShareBuilder Options Account Agreement seems ambiguous, but their options trading page implies the upgrade.

In a cash account, equities are not marginable, so any margin will trigger a margin call. If the margin debt did not trigger a margin call then it is unlikely that it is a cash account as margin for any security in a cash account except for certain options trades is 100%.

Equities are convertible to cash presumably at the bid, so during a call exercise, the exercisor or exercisor's broker pays cash for the underlying at the exercise price, and any deficit is financed with debt, thus underlying can be sold to satisfy that debt or be sold for cash as one normally would.

To preempt a forced exercise as a call holder, one could short the underlying, but this will be more expensive, and since probably no broker allows shorting against the box because of its intended use to circumvent capital gains taxes by fraud. The least expensive way to trade out of options positions is to close them themselves rather than take delivery.

  • Thanks for your reply @quantycuenta. The call option that I purchased is actually deep in the money. I suppose what I'm mainly asking is if I can sell the stocks that were automatically exercised to cover for the negative cash balance in my account? Or am I not allowed to sell these stocks until I have covered all the money that ShareBuilder used to pay for the stocks? – Tung Feb 1 '14 at 19:58
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    I have never explicitly opened a margin account. Ihave been trading with only my own money. Are you saying that, with the automatice exercise of these call options, my account is now a margin account? Ultimately can Isell the stocks if I never had the cash to purchase them in the first place. Can I do this before the settlement date – Tung Feb 1 '14 at 20:35

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