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Let us say I lock in a small riskless profit using a conversion. Which means (as an example), I sell a call, buy a put and buy stock, and net a credit of .20.

What do I do next? Do I just let the whole position go to expiration and exercise/get assigned? Does an early assignment hurt the riskless profit I made?

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    Don't forget fees. If you are assigned, your broker may charge you a fee to process the assignment, and that commission may be the same as or perhaps more than your usual trading commission. – Chris W. Rea Mar 17 '15 at 15:45
  • Thanks. I am using IB, exercise/assignment is free, and commissions are 1$. – Victor123 Mar 17 '15 at 18:21
  • IB has better fee structure than most. Traders at other brokers might have to plug their trading and assignment fees into a spreadsheet, then create a sort of calculator to breakdown which exit strategies are most profitable. Ideally this would be done prior to entering the trade. In your case, you aren't really saving much either direction, so no worries. – Knuckle-Dragger Mar 17 '15 at 19:15
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To Chris' comment, find out if the assignment commission is the same as the commission for an executed trade. If that does affect the profit, just let it expire.

I've had spreads (buy a call, sell a higher strike call, same dates) so deep in the money, I just made sense to let both exercise at expiration. Don't panic if all legs ofthe trade don't show until Sunday or even Monday morning.

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This depends on a combination of factors: What are you charged (call it margin interest) to hold the position? How does this reduce your buying power and what are the opportunity costs? What are the transaction costs alternative ways to close the position? What are your risks (exposure while legging out) for alternative ways to close? Finally, where is the asset closing relative to the strike?

Generally, If asset price is below the put strike then the call expires worthless and you need to exercise the put. If asset is above the call strike then put expires worthless and you'll likely get assigned.

Given this framework: If margin interest is eating up your profit faster than you're earning theta (a convenient way to represent the time value) then you have some urgency and you need to exit that position before expiry. I would not exit the stock until the call is covered. Keep minimal risk at all times.

If you are limited by the position's impact on your buying power and probable value of available opportunities is greater than the time decay you're earning then once again, you have some urgency about closing instead of unwinding at expiry. Same as above. Cover that call, before you ditch your hedge in the long stock.

Playing the tradeoff game of expiration/exercise cost against open market transactions is tough. You need sub-penny commissions on stock (and I would say a lot of leverage) and most importantly you need options charges much lower than IB to make that kind of trading work. IB is the cheapest in the retail brokerage game, but those commissions aren't even close to what the traders are getting who are more than likely on the other side of your options trades.

  • Thanks. I knew it could not be as simple as just letting it expire. – Victor123 Mar 18 '15 at 1:40
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Let's assume that the conversion or reversal is profitable after margin interest (if any), borrow fee (if any) and opening commissions. You don't have to do a thing unless the underlying is about to expire ATM (see below).

The OCC will automatically exercise any option that is one cent ITM at expiration (Exercise By Exception). So regardless of where price is, the position is gone at no cost because assignment and exercise is free at IBKR.

Early assignment will cut into your 20 cent profit. If the stock is ITM versus your long option, you will have closing B/A slippage and one commission on the short OTM leg. If the stock is OTM versus your long option, you will have B/A slippage and commissions when closing all three legs.

If the underlying is about to expire near ATM, you may be assigned on one leg. You won't know that until after your long leg has expired and Monday morning you may have a long or short position in the underlying and then have 100% directional risk. This is called PIN RISK and must be dealt with before expiration, cutting into your 20 cent potential profit.

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