Explore Your Options
| Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C. |
Tom Gentile of Optionetics |
WHAT TO DO WHEN ASSIGNED
If I hold a stock in my portfolio and I sell calls on the stock, what do I do if faced with assignment? That is, if the call owner wants to exercise the call option, how will I know and how can I deliver the stock?
If you own the stock and sell the call on that stock, you will set up a trade known as a covered call or a buy-write. It is a popular strategy that can be used to generate income in a portfolio and also lower the cost of owning the stock. However, as you note, the gains from the strategy are limited because, if the stock moves higher, the call will be exercised by the owner and assigned to you, the option seller. At that point, the call seller must deliver the shares to the call owner.
So, if the stock price is above the strike price of the call option at expiration, assignment of the short option is probable. To avoid assignment, the call seller can close the position. However, if the call seller is assigned, they don't have to do anything. The broker will deliver the shares to the option seller. The broker will also deliver an assignment notice to inform the seller that the transaction is taking place. Most brokers also charge a commission for exercise and assignment.
STRAIGHT PUT VS. BEAR PUT
When is it better to just buy a straight put or call, as opposed to placing a bear put spread? In most situations, won't a simple put double your money faster, even though it costs a little more?
Choosing between a straight put and a bear put spread really depends on time frame and expectations about volatility. If you are a short-term trader, a spread doesn't make sense. You will probably pay more in commissions and you will also have more slippage because, with the spread, you are trading two options. By slippage, I mean the money that is lost due to the spread between the bids and offers. For example, if the XYZ June 30 puts is quoted at $1.30 bid and $1.40 ask, a market order to buy will get executed at $1.40. If I turn around and sell at the market, the put will be sold for $1.30. My loss on the trade is $0.10 and is due solely to slippage.
If the stock or market is expected to go down, I might set up a bear put spread. To do so, I buy one put and then sell another put with a lower strike price. However, to close the position, I need to sell the put with the higher strike price and buy back the put with the lower strike price. As a result, the trade suffers slippage twice. Therefore, for short-term trading, the straight put or call purchase has an important advantage. It will result in less slippage.
However, we don't advocate short-term or frequent trading in the options market. Instead, when holding positions for more than 60 days, spreads are often superior. For one, longer-term and less frequent trades will lead to lower commissions and less slippage. In addition, if you trade stocks with high prices or stocks with high volatility, then spreads will probably be superior to straight call and put purchases because high priced stocks and stocks with high volatility tend to have higher option premiums. Setting up the spreads helps to reduce the cost of the trade and also results in a lower overall risk profile.
OEX VS. SPX
What is the difference between the OEX and the SPX?
The Standard & Poor's 500 ($SPX) and the S&P 100 ($OEX) are both indexes that consist of shares of large US companies. Like the Dow Jones Industrial Average ($INDU), investors use these two indexes to track the performance of the stock market. In addition, traders use the OEX and SPX as trading vehicles to profit from price moves in the US market.
While both the SPX and OEX are used to track and trade the stock market, important differences between the two exist. First, the S&P 500 includes 500 stocks. In contrast, the S&P 100 includes only 100. Therefore, the SPX tends to be a bit less volatile than the OEX because it has a greater number of stocks.
The way the options settle is also different. To be specific, options on the S&P 500 settle European style, which means that exercise and assignment can only occur at expiration. The S&P 100 options settle American style, and therefore exercise and assignment can occur at any time prior to expiration.
Many index traders prefer to trade European-style options contracts because it removes the risk of early assignment, which is important when dealing with cash based index options. For that reason, the Chicago Board Options Exchange (CBOE) also created the European-style S&P 100 options. Trading under the symbol XEO (which is OEX backward), these options are identical to OEX options, but settle European rather than American style.
Finally, while OEX options date back longer than options on the S&P 500, they are not as liquid. The CBOE first launched index trading on the S&P 100 in 1983. It was the first index to have listed options and quickly became one of the most actively traded contracts for many years. Since that time, however, the S&P 500 as well as a host of other index options have become more popular. Therefore, the SPX sees more trading volume and offers better liquidity than the OEX.
Originally published in the May 2005 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2005, Technical Analysis, Inc.
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