Profit and Risk

[responsivevoice_button rate=”0.9″ pitch=”0.5″ volume=”0.8″ voice=”US English Female” buttontext=”Play”]The box spread SPY written about in yesterday’s post has expired. SPY closed at $362.79. The call side of the spread expired OTM and the put expired ITM. We had received a combined credit on the spread for $130 ($40 on the call side, $90 on the put side). Because the call side was OTM, it expired worthless, and we kept the $40 credit. The put side, however, expired ITM on both legs, meaning that it retained its extrinsic value (the difference between the strikes of the spread) after expiration. The spread has us buying 100 shares of SPY at $383 per share and selling 100 shares at $382 per share–a net loss of $100. The $90 credit we received when we opened the put spread gave counterbalanced the loss at expiration, and our final loss on the put side of this trade was only $10. The table below summarizes what I’ve just described.

What would have happened if SPY at expired at $382.50? Then the short put would still be ITM, but the long put would be OTM. The short put would obligate us to buy 100 shares of SPY at a cost of $38,300. Meanwhile, the long put would expire worthless. We could, however, sell the 100 shares of SPY that we’ve been assigned at the market price when trading resumes on Monday morning. Unfortunately, we don’t know what level SPY will open at on Monday. We could get lucky, and maybe SPY will open higher than yesterday’s close. Or it could open yet lower. We can not longer define the risk we have taken on. On May 13, 2019, the S&P 500 gapped down 3.35%. An overnight loss of this magnitude on holdings of $38,300 would be $1283.05. The net $130 credit received on the four trade contracts would reduce this loss to $1153.05.

A final point: Remember that American options can be exercised early, which means that short contracts can be assigned early.

Key take-aware: Thoroughly and continuously consider potential assignment risks when managing trades. Don’t be like 1ronyman.