Prologue

This week’s post reviews my actions in dealing with an unexpected Assignment to the short-leg of a spread.

What I will not cover below is how to manage the in-the-money covered/uncovered call option when approaching ex-dividend. Tips on avoiding pay the dividend will be covered in a later post.

Late last month, I opened a Vertical Bull Call Debit Spread for IWM. This position started as a regrettable decision because I did not follow most of my entry rules. Still, after a couple of weeks, it started working with me, and both legs appreciatively moved deep ITM.

One datum point that I did not check before opening the position was to see if the ETF IWM will be entering the ex-dividend date while the spread is active. Entering the ex-dividend date while the any legs are OTM is not a problem. But a Call Debit spread only works when ITM.

Any underlining stock or ETF used as a derivative in an option contract, and is ITM, and enters the ex-dividend data will have a high probability of being assigned. This assignment-gotcha happened to me this week with the IWM position below.

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IWM: 160c/161c – 1 Contract – Open 11/25 – Expires 12/20 – Debit = $50.00
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 44.5%, ROR = 94.1%, PC/Ratio = .77, Max Gain = $48.00, IV% = 2%
Prob of ITM now = 97%

Think or Swim

On 12/13/19, both legs of my IWM debit spread were comfortably ITM. Yeah! I’m winning.

On 12/13/19 (Friday), I received a warning from Ameritrade that my short leg contract (161-Strike Call Option) was at risk of assignment due to IWM entering “Ex-Dividend Date” the next business day. I was out of pocket when I got this warning (e-mail) and could not do anything about it that day.

On 12/16/19 (Monday), I had my first indication that my 161-Strike Call Option contract was assigned the previous Friday. Unbeknownst to me, Ameritrade automatically sold 100 shares of IWM (iShares Russell 2000 ETF) (that I did not have) for the $161 per share contract price. I received $161.00 * 100 shares = $16,100 from this transaction. But since I did not have 100 shares of IWM to sell, I was required to borrow the 100 shares from Ameritrade to sell so I could complete my side of the deal.

As part of the assignment process, the 161-Strike Call leg of my debit spread was removed due to the assignment.

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So when I logged on Monday morning, I saw this:

  • $16,100 in new cash – Yeah!
  • an IOU to Ameritrade for 100 IWM shares with a now market value of -$16,417 – Boo!
  • My remaining long-leg of my IWM:ETF option contract (160-Strike Call Option)
  • A Regulation T Margin Call warning that I’m about to get castrated for the shares I owed Ameritrade if I don’t settle up – Gulp!
  • My account locked from new trading until the Margin Call was satisfied.

The first thing I needed to do is to get squared with Ameritrade and remove the doom of Reg-T from over my head. The only way to do that is to buy the 100 shares of IWM that I borrowed at the now current ETF price of $164.17 a share. But I did not have the $16,417 to cover that cost, just the $16,100 from the above forced short sell due to the assignment.

On First Thought…

My first thought was to exercise the 160-strike leg of the spread (do on to others what others did on to me). This is what the long-leg part of my spread is for. This action would have allowed me to buy 100 shares of IWM for the Option’s contract price of $16,000 (160-strike * 100 shares). Since I now have the $16,100 in my account, this exercise transaction would bring in the 100 shares that I owed to Ameritrade, plus I would realize a juicy profit of $100.00 ($16,100 cash received from the assignment’s short sell – $16,000 paid for the exercising the long sell).

This “first-thought” action would have made the 11/25 Vertical Bull Debit Call Spread a juicy profit of $50. (+$100 received from completing the closing of the position – $50 debit for opening the trade – fees).

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On Second Thought…

But on second thought, I decided to consider analyzing any opportunities with the remaining long leg option.

I still own a 160-Strike Call Option contract for IWM. With the ETF’s current value of $164.17, I calculated the intrinsic value for my contract at $417 ($164.17 current ETF value – $160 short-strike contract value = $4.17/share * 100 shares). But since I still have 5 days left in the options’s contract, there is still an additional extrinsic value of $14.47 ($4.3147 as the current value of the 160-strike call option as listed on the 11/16/19 Options Table * 100 shares – the $417.00 intrinsic value = $14.47 extrinsic value).

So instead of simply exercising my long call option and call it even, I chose to instead sell-to-close my 160-Strike Call Option contract for $431.47 and, at the same time, buy-to-close the short 100 shares of IWM for $16,417. The net profit I can make from this second-thought was even a juicier $114.47 ($16,100 starting cash + $431.47 credit from selling long option – $16,417.00 to buy-to-close my short IWM shares).

Executing this second thought option, made the 11/25 Vertical Bull Debit Spread a profit of $64.47 ($114.47 received from the second-thought transactions – $50 debit for opening the trade). The extra 15-ish dollars I received was from the remaining extrinsic value of the 160-Strike Call Option that I still owned, and would have given away if I just “exercised” the option instead. – Good second thought!

Lesson Learned

There are a couple of lessons to remember:

  • Having the long-leg of a spread as insurance is important even if the spread is going your way. If I would have closed the long-leg early because (gee-whiz) my short-leg is doing great, then the unanticipated ex-Dividend Date Bomb would have cost me $417.
  • “Exercising” the long leg as the panic, knee-jerk reaction when the short leg becomes assigned could naively toss-out any extrinsic value left in that contract. So don’t be too quick to pull that exercise trigger.
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This Week’s Market Sentiment

As of 12/16/2019

General Volatility:

VIX = 12.1, a calming from 15.90 last week
Put/Call Ratio 9-day SMA (all OCC options): .76, slightly up from .72 last week
Consumer Sentiment Index (CSI): 99.2, flatline from 99.2 last week
DOW 28,272, up 1.4% from 27,882 from last week
S&P 3,195, up 1.9% from last week’s 3,134

Think or Swim
3-month Put/Call Ratio Graph for All OCC Options as of 12/17/19

The most significant notable from the above Put/Call Ratio chart is the daily ratio dropped back down into the trend channel. But the 50-day SMA has been slightly rising for nearly a month before retreating recently. Also, the frequency of the daily-ratio has widened, as if we are waiting for something to happen. (Maybe an Impeachment reaction…)

Additionally, the Put/Call Ratio’s 50-day SMA has dropped below the 200-day, signaling a lack of general pessimism for the markets in the short term, and the 9-day SMA is still in the Bullish territory.

VIX is slightly below 15, indicating that there is not too much indecision as to which direction the market will move. The direction it is moving now will most likely continue.

The CSI being higher than 99% for several weeks is what seems to stand out the most. The Consumer Sentiment Index is a gage between 0 and 100%, and a value higher than 99% suggests that the top end bounds it. No one appears to be worried about our economy – even through various Impeachment and US/China trade talk skirmishes.

Geopolitical tree-shakers are:

  • There is agreement on the USMCA.
  • Trump was impeached in the House this week, but this had no effect on the market since everyone knows he will be acquitted in the Senate.
  • Dec 15th scheduled China tariff hike was delayed in light of a Phase 1 agreement.
  • Brexit became more certain after Boris Johnson was reelected PM
  • Little of the usual end-of-year profit-taking

My sentiment for this coming week

There seems to be little confliction in the market direction as of mid-Dec. I was expecting (and still do) a brief market downturn before the end of the month as other Marketeers make tax adjustments and taking profit for the year. But the VIX, CSI, and P/C Ratios seems NOT to support this expectation.

If I were making trades this week, I would focus solely on Bull Strategies.

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Profit and Loss Statement

As of 12/20/2019

  Year MonthWeek #
  2019Dec51
Beginning Account Balance N/AN/AN/A
 Deposits$0.00$0.00$0.00
 Widthdraws$0.00$0.00$0.00
     
 Realized Profits
(closed spreads)
-$438.00-$63.00$0.00
 Unrealized profits
(open spreads)
$70.00$49.00$0.00
 Fees Paid (total)-$695.40-$3.00$0.00
     
Ending Account Balance N/AN/AN/A
     
Total Gain/Loss -$1,063.74-$17.00$0.00
Return On Risk N/A-3.8%N/A
Return On Capital <undetermined>N/AN/A

Realized Profit by Strategy

 YearMonthWeek
 2019Dec51
Vertical Bull Put Credit Spread-$139.00$0.00$0.00
Vertical Bear Call Credit Spread-$435.00-$63.00$0.00
Vertical Bull Put Debit Spread$0.00$0.00$0.00
Vertical Bull Call Debit Spread$140.00$0.00$0.00
Icon Condors-$4.00$0.00$0.00
Cover Calls
Total-$438.00-$63.00$0.00
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Schedule for this Week

Goals for Week: (12/16/19 – 12/20/19) (Week 51)

  • Do not make any spread trades that will live past Dec 31.
  • Max technical dollars at risk = $750, dn from $1,000 (see Market Sentiment section)
  • Max dollar risk per trade = $350, dn from $500 (see Market Sentiment section)
  • Place no more than one trade per day – except Friday (catch up day).

Monday:

  • Determine/update this week’s market sentiment section.
  • Calculate/record Put/Call Ratios for all stocks on the watch list. Determine direction.
  • Review/tweak Trend-Channels for all stocks in the watch list.
  • Confirm that the target expiration date for all options trades is set as follows:
    (This week’s trade duration was shorted due to the EOY barrier.
    • Bull Put Credit Spreads: Dec 27 (2-weeks).
    • Bull Call Debit Spreads: Dec 27 (2-weeks).
  • Stage possible trades for all watch list stocks by 10:00 AM
  • NO TRADING BEFORE 10 AM. (Let the market find its direction after the weekend.)
  • Watch one Webcast or take one online mini-course to be completed by Friday.  

Tuesday – Thursday:

  • Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movement as “long-shots”). 
  • Submit a couple of Spreads, but keep a close watch. If one takes, cancel the others (we just want one new active trade per day). 
    • Balance the spread strategy (Call/Put) to minimize actual risk for that expiration date.
  • Update trading log file and journal (this blog) with any accepted trades.

Friday:

  • Review the total technical dollars at risk for this week. If significantly below $1,000 then submit additional spreads.
  • Update and post weekly journal (this blog) with any lessons learned or strategy changes.
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This Week’s Trade Activity

As of 12/20/2019:

As of this post, I only have two positions still open. And these positions will expire by the end of next week (12/27).

Spread Count Summary:

 YearMonthWeek #
 2019Dec51
Vertical Bull Put Credit Spread6110
Vertical Bear Call Credit Spread1210
Vertical Bull Put Debit Spread000
Vertical Bull Call Debit Spread1100
Iron Condor200
Margin Interest Paid100
    
Total Spreads8720

Current Dollars at Risk:

 YearMonthWeek #
 2019Dec51
Vertical Bull Put Credit Spread$630$451$0
Vertical Bear Call Credit Spread$0$0$0
Vertical Bull Put Debit Spread$0$0$0
Vertical Bull Call Debit Spread$0$0$0
Iron Condor$0$0$0
    
    
Total Dollar Risk$630$451$0
Max Risk Allowed$4,500.00 $1,000.00
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New Trades Opened (all of Dec)

This month I am winding down all my active trades and limiting any new trades. The goal this month is to zero out my account so I can start new in Jan. Working towards this, I have not published a Journal Post for the past two weeks. So there are trades that were opened, cooked and closed listed below. This should explain the duplicate positions below.

SPY: 298p/293p – 1 Contract – Open 12/4/19 – Expires 12/27 – Credit = $49.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 82.3%, ROR = 10.7%, PC/Ratio = 1.8 and falling, Max Risk = $450.00, IV% = 10%
Prob of OTM now = 97.6%

Think or Swim

Entry rules for Vertical Bull Put Credit Strategies

  • Expiration date set at 6 weeks – No trades beyond 12/31/19
  • Probability of OTM 80%-85% – Yes
  • Dollar risk set at individual trade max – Yes
  • Put/Call ratio below .75 and dropping – No. but it is dropping
  • Short strike price below trend-channel at expiration – Yes
  • Short strike price below 1 standard deviation from current price -Yes
  • Current ETF price within bottom 3/4 of trend channel – ah, close enough
  • 9-Day SMA above 50-Day SMA – No
  • ROR > 7.5% – Yes

I opened this trade because SPY’s IV% dropped significantly over the past 24 hours after word came out that the US/China Trade deal was close. The P/C Ratio remains flat but in bearish territory. And the 9-day SMA is still below the 50-day but has rebounded.

The Short-Strike price of $298 is more than three strikes below one standard deviation off the current SPY price of $311.68. I see this a super-conservative, considering I am expecting an EOY pullback.

IWM: 165c/170c – 1 Contract – Open 12/3/19 – Expires 12/20 – Credit = $24.00
(Vertical Bear Call Credit Spread)
Open: Prob. OTM = 89.6%, ROR = 4.8%, PC/Ratio = 2.7, Max Risk = $475.00, IV% = 22%
Prob of OTM now = 59.6%

Think or Swim
IWM – 12/03/19

Entry Rules For Vertical Bear Call Credit Spread

  • Expiration date set at < 4 weeks – Yes
  • Prob-OTM near or greater than 90% no
  • Put/Call ratio above 1.2 and rising – Yes
  • IV% above 15 – Yes
  • Current ETF price at or above the top side of the trend channel – No
  • Short strike price at or above 1 standard deviation from current price – No
  • Short strike price above trend channel at expiration – Yes
  • 9-Day SMA below 50-Day SMA – Yes
  • ROR > 8% – No

(Of the 9 rules listed, I violated more than half. Retrospecting, I should have either not enter this trade.)

IWM has jumped into bear mode over the five days before opening this position, and my general market sentiment for this week is that it will continue down, or at least go flat through the end of this year.

The short strike price of $165 is just below the 1-SD price of 165.75, as calculated on the now high IV. But the strike price is still above the trend channel for a Dec 20th expiration date.

The Prob-OTM is 89.6%, which is barely lower than my Entry-Rule threshold of 90%, but with the IV rising fast, making the premium that was offered is more attractive. The 9-day SMA is now below the 50-day and falling.

Finally, I currently have an IWM Vertical Bull Debit Spread with a Long strike price of 160 cooking. This debit spread is not reacting well with the change in market sentiment. Because both of these trades have the same expiration date, this new trade will act as a counterbalance (Iron Condor like).

After this trade was accepted, I notice that the Long Strike price of $170 on this 5-strike wide Spread only got me an extra penny ($.01). So for a dollar (or $.01 * 100 shares = $1.00) I took on $100 worth of risk. One strike shorter ($169) would have only cost me $.03 ($3.00) to lower my dollar risk by $100. So an IWM 165c/169c trade would have given me $21.00 in premiums but with a max risk of only $277. And my ROR would have been a good 7.6%. I need to start paying better attention to the long-end of the spreads.

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Trades Currently Cooking

Only two positions left. By this time next Friday, these will be gone as well.

IWM: 155p/153p – 1 Contract – Open 11/29 – Expires 12/27 – Credit= $21.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM= 83.2%, ROR = 12.5%, PC/Ratio = 1.64, Max Loss= $176.00, IV% = 4%
Prob of OTM now = 96.3%

SPY: 298p/293p – 1 Contract – Open 12/4/19 – Expires 12/27 – Credit = $49.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 82.3%, ROR = 10.7%, PC/Ratio = 1.8 and falling, Max Risk = $450.00, IV% = 10%
Prob of OTM now = 97.6%

Current Trades Closed

IWM: 160c/161c – 1 Contract – Open 11/25 – Expires 12/20 – Debit = $50.00
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 44.5%, ROR = 94.1%, PC/Ratio = .77, Max Gain = $48.00, IV% = 2%
Prob of ITM now = 52%

See Prologue above for information about this trade.

SPY: 294p/289p – 1 Contract – Open 11/15 – Expires 12/20 – Credit = $31.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 86.1%, ROR = 6.4%, PC/Ratio = 1.41, Max Risk = $468.00, IV% = 6%
Prob of OTM now = 99.5%

Expired OTM.

IWM: 165c/170c – 1 Contract – Open 12/3/19 – Expires 12/20 – Credit = $24.00
(Vertical Bear Call Credit Spread)
Open: Prob. OTM = 89.6%, ROR = 4.8%, PC/Ratio = 2.7, Max Risk = $475.00, IV% = 22%
Prob of OTM now = 20.2%

When I opened this position, it was deliberately paired with the IWM:160c/161c Vertical Bull Call Debit Spread (see Prologue). Sort of an Iron Condor. I opened this trade because I misread the market direction after two weeks into the 160c/161c Debit Spread’s life and got too concerned about it not ending in a profit.

The short leg of this spread (165 strike) went ITM on Wednesday (12/18/19) and bounced in and out of ITM from then until Friday morning – expiration day. As well, the prob-OTM fell below 15%. So by early Friday, I accepted the reality that this spread will not win the day, and the short-leg will be assigned (if I let it go). The anticipated dollar loss could be fairly high.

My closing solution was as follows:

I created this Bear Credit spread to be paired to the Bull Debit spread as stated earlier. So I will ostensibly look at these two positions as one.

The IWM:160c/161c Vertical Bull Call Debit Spread closed 12/16/19 with a net profit of $64.47 (see Prologue above). The premium collected from this IWM:165c/170c Vertical Bear Call Credit Spread was $24.00 (See New Trades Opened above). So on Friday morning, I submitted an order to close the IWM:165c/170c position for a debit of $.88 (+$64.47 from the Debit Spread + $24.00 collected from this Spread = $88.47 / 100 shares = .88.

Therefore:

  • IWM:165c/170c closed at .88 * 100 shares = -$88.00
  • IWM:165c/170c premium collected at open = +$24.00
  • IWM:165c/170c gross profit = -$88 + $24 = -$64.00
  • IWM:160c/161c gross profit = +$64.47
  • Combined positions gross profit = -$64.00 + $64.47 = +$.47 (a moral victory only!)
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Epilogue

The moral victory in my faux Iron Condor machination described above was unceremoniously ripped away when I learned and had pay, the dividend price of $59.73 from the IWM:161c leg that was assigned. Even though the gross profit from the IWM:160c/161c was a nice $64.47. Now with having to pay the dividend as well made the trade $64.47 – $59.73 =$4.74 (still a winner for this trade). But will combined with the $64.00 loss for the 165c/170c position made the effort a $4.74 – $64.00 = -$59.26 defeat.

A future post will cover how to manage better those positions that are in danger of ITM ex-dividend assignments.

Cheers…

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