I get this question many times so I thought it good to address here.
You are in a calendar or diagonal that has gone way into the money for the short side. Because of this you cannot roll out to the next month and get any preimium. What do you do?
Let us walk through a live example. Back in Oct I went long GDX Jan 09 (a leap) 44. I then sold the Nov 45. Rolled the Nov to Dec and again to Jan, Feb and once more to Mar. I was gaining about 1.00 for each roll (now some months less and some months more).
As we all know gold (GDX is gold stocks) has gone throught the roof. So I am deep in the money on my Mar short as well as my '09 Jan long. Today if I were to roll to the next month I would get .40 Not worth it. So I have some decisions to make.
#1 Buy back the 45 and sell a higher option. This is not good since I will be buying the short option for a loss and then selling the higher one for not as much, but then I will be at a higher strike price for my long option.
#2 Is my preference. Let the short option get assigned, now I am short GDX, buy it back to close which is basically a transaction the same day. And I am out the comission. Now I can sell the next month higher strike.
Word of caution here, if the stocks should rise dramatically from Mondays open, I would lose on the short shares, however I still have the long option that would cover this.
Just thought this would be helpful. I am still very bullish gold and want to stay in the game.
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2 comments:
Dell, Can you explain a little bit more about what happens when you are assigned. How the transaction works without having to sell your long position. I have been thinking about doing this with a short position that still has alot of extrinsic value at expiration.
Say if it was .50 in the money, but the value of the short was 1.50. Would someone assign me and would I keep the $1.00. Thanks Debbie
If the option is in the money by .05 at the time of ex date (expiration date) it will be automatically assigned (new rules)
What happens is you are now short the stock you have sold short the amount of shares X 100 for each option sold. Now if the stock opens the next day up, you are losing on the short side since you are short the stock and want the stock to drop. but your long option will gain. Thus offsetting the short stock.
Remember you can get assigned anytime. But you usually will not as long as there is extrinsic value in the option price.
In your example you would keep the extra dollar. but why would anyone assign this? Lets think this through.
I can sell my option for 1.50 or I can exercise my right and own the stock for a .50 gain (.50 in the money means the stock is .50 above the strike price) Which one is better?
Back to the assignment, when you get assigned, your broker lets you know. You now have to take care of this before the end of the close that day or they will take care of it for you. If you have enough equity in the account they will let it ride. If you do not, they can sell the long option position and buy to close the short stock and you are out of the position.
If in my example I wish to stay with my long option, I buy back the short shares to close out the short position and then can now sell my long option or sell another higher strike option, etc.
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