Risk Question - Short Options in Big Market Move

[tjlocke99 18]

Good afternoon. After reading Chris's post on options and reverse stock splits, it made me think of 2 MAJOR potential risks to being short an option even when it is covered:

1. There is a "flash crash" or "short squeeze" type of move in an individual stock you have a short option on. In this case couldn't you be exercised on the short at some major loss and your long option still be open? Then the stock quickly comes down to earth and you have a MAJOR loss on your hands.

2. There is a major event that causes the whole market to move up or done ALOT. You can have the same issue as #1.

Anyone electronically trading options around Sept 11, 2001 with some shorts who can share their experience or the flash crash from last year?

Thanks!

Richard

[Kim 7,943]

If you are exercised, then you will have the stock to offset the puts. You can close both and you should be okay.

[tjlocke99 18]

I guess my point is if I am not able to reach a terminal more than once at most during the trading hours and the following happens I could be completely screwed right?

Let's take a hypothetical example:

I own this AAPL RIC: 595/605/635/645

AAPL is at 620

AAPL has a flash crash and the following happens:

at 1030 AAPL rises briefly from 620 to 730 and then at 1045 AAPL is back 630.

When AAPL hits 690 mark I am exercised on my short 645 CALL position and I end up short 100 shares of AAPL and get paid $64,500 in cash. I can't cover the margin requirements of being short 100 shares of AAPL so my broker within 10 minutes is liquidating my positions sequentially. I believe IB has told me that they don't liquidate in any particular order so this could make it worse. By the time IB starts liquidating my 100 short position the stock has now climbed to 720. I am therefore buying back the stock at $72,000.

So here is where I am:

I have $64,500 in cash from the purchase of the short call I owned

I paid $72,000 to buy back my short.

I am out $7500 on a ONE position RIC! Oh but you say I have that long 635 call. Well I am not on my terminal all day, so by the time I am back to my terminal AAPL is back to 635. My call is worth close to what I paid for it. I also don't have a short covering it, so I am directional.

I know I got paid some money for the 645 Call too but the point is this is ONE position, and I've lost a ton. Now imagine we have a terrorist attack like Sept 11 and all your short options tank!

Isn't this a situation where you go bankrupt and lose it all?

I'd love some feedback on this.

Thanks!

Richard

[Kim 7,943]

The situation you describe is not possible because assignment doesn't happen in the middle of the day. It happens overnight, you will not that you are assigned only in the morning, and then you have time to cover the stock and sell the long option. This situation will actually benefit you because the long option will still have some time value, so you will get more than $10 for your 635/645 $10 spread. Most of the time you should be happy to be assigned.

[tjlocke99 18]

The situation you describe is not possible because assignment doesn't happen in the middle of the day. It happens overnight, you will not that you are assigned only in the morning, and then you have time to cover the stock and sell the long option. This situation will actually benefit you because the long option will still have some time value, so you will get more than $10 for your 635/645 $10 spread. Most of the time you should be happy to be assigned.

This is great information Kim! If someone exercise their long call at 10:30 in the morning then don't they get the price at the time they exercised their option? If I am assigned before 0930 ET the next day then what price is used for the underlying? What price would I have to sell AAPL at in this example?

You mean you can make moves in the pre-market to secure yourself? However you can't sell the spread itself right and be out of the position? At what point will you have that -100 shares of AAPL?

Thank you very much!

[Kim 7,943]

The price is the price of the strike you are short, the current price doesn't matter. So if you are assigned at your 645 short, you are short the shares at $645.

Here is a good explanation how this is working -

http://www.cboe.com/LearnCenter/Concepts/Beyond/expiration.aspx

http://www.1option.com/index.php/ask_me/comments/how_does_assignment_work/

http://www.1option.com/index.php/ask_me/comments/i_need_to_know_when_im_assigned_why_is_option_assignment_notification_so_sc

http://www.1option.com/index.php/ask_me/comments/exercise_assignment_and_spreads/

http://www.optionseducation.org/tools/faq/options_assignment.html

[tjlocke99 18]

The price is the price of the strike you are short, the current price doesn't matter. So if you are assigned at your 645 short, you are short the shares at $645.

Here is a good explanation how this is working -

http://www.cboe.com/...expiration.aspx

http://www.1option.c...ssignment_work/

http://www.1option.c...ification_so_sc

http://www.1option.c...nt_and_spreads/

http://www.optionsed...assignment.html

Thanks Kim.

Here is what I mean. Up front, I know this is not realistic due to extrinsic value, but this is to illustrate the point. I also know you can just sell the option. Let's say I own an AAPL call at 550. I exercise it when the stock is at 620 with the thought I will sell the 100 shares immediately and realize the gain. IF I exercise the 550 when do the 100 shares show up in my account? The following morning? At that point the stock could be at 540, and I lose out.

Thank you VERY much!

[Marco 223]

Thanks Kim.

Here is what I mean. Up front, I know this is not realistic due to extrinsic value, but this is to illustrate the point. I also know you can just sell the option. Let's say I own an AAPL call at 550. I exercise it when the stock is at 620 with the thought I will sell the 100 shares immediately and realize the gain. IF I exercise the 550 when do the 100 shares show up in my account? The following morning? At that point the stock could be at 540, and I lose out.

Thank you VERY much!

With IB they show up instantly so you can trade them = not sure how it works with other brokers. Otherwise you can always just sell your deep in the money option (although spreads on DITM options will be much bigger than on the stock so exercising would be better)

[Kim 7,943]

Thanks Kim.

Here is what I mean. Up front, I know this is not realistic due to extrinsic value, but this is to illustrate the point. I also know you can just sell the option. Let's say I own an AAPL call at 550. I exercise it when the stock is at 620 with the thought I will sell the 100 shares immediately and realize the gain. IF I exercise the 550 when do the 100 shares show up in my account? The following morning? At that point the stock could be at 540, and I lose out.

Thank you VERY much!

But this is no different from having the option - if the stock goes down, you lose as well.