Thursday, August 5, 2010

Odds of Assignment

It's been awhile since I tackled some viewer questions, so here ya go:

I've been trading a calendar spread on VMW by selling short term calls against my Jan 2010 60 strike LEAPS call option. Currently I'm short the Aug 75 call option which has moved notably ITM due to the strong performance of VMW this month. Though the short option had about $400 time value a few weeks ago, it now only has $78. I've done this strategy for awhile and it has worked out nicely, but I haven't been faced with this dilemma. I don't want to close the position, nor do I want to be called out. Am I at risk of being called out? How?

Hey David,

Anytime I want to assess my odds of early assignment (you never really know for sure if it's going to happen), I consider three things: Is the short option ITM? Is it trading close to parity? Is the stock close to its ex-dividend date?

The first question is a no-brainer as no one in their right mind would exercise an OTM option. With VMW residing around $81.10, the Aug 75 call is certainly residing ITM. When we say an option is trading close to parity, that simply means it's trading close to its intrinsic value and possesses little to no extrinsic (time) value. As of this morning I'm seeing it trade for about $6.80. $6.10 of that is intrinsic value, the other $.70 is extrinsic. Based on the $70 remaining, I'd say your odds of assignment are still quite low.

Remember that option owners lose the extrinsic value when they exercise. So if someone owned the 75 call and exercised it, they would effectively be giving up the $70. Consequently, they are better off simply selling the call to close the position. Occasionally if the ex-dividend date is approaching and they want rights to it, investors may opt to exercise the call and buy stock. Thus, you may also want to consider whether an ex-dividend date is looming on the horizon.

1 comment:

King Kong said...

I have never invested in options. I believe that investing in anything with an experation date is a bad idea.