A number of you have been receiving notices from your brokers warning that your short call position in the SPDR S&P 500 ETF (SPY) April, 2017 $230-$233 in-the-money vertical bull call spread may get called away.
They are specifically referring to the short April $233 calls.
Brokers have recently started doing this to avoid getting sued for failure to give notice, which they always do.
While it is theoretically possible that your April $233 calls could get called away, it is highly unlikely.
Let me do the math to show you why.
The SPY is currently trading at $237.70.
The April $233 calls are trading at a mid price of $6.02, which expire in 25 trading days on April 21st.
The April $233 calls have an intrinsic value of $4.70 ($237.70 – $233.00 = $4.70). So The April $233 calls are therefore trading at a $1.32 premium.
If the holder of this call exercises his position he will lose the entire $1.32. The dollar value of the 38 contracts we are short is $5,016. So it is highly unlikely that the holder will exercise the position.
March 17th is ex-dividend day for the SPY, so holders of the calls are entitled to receive $1.03312 for each share they own.
For the 38 contracts of the April $233 calls you are short, that works out to $3,925.85 in dividend payments. If the calls are exercised against you, you are liable for this amount of money.
In other words, exercise would cost the call owner -$1,090.15, plus whatever commissions and exchange fees he may have to pay.
Having said all that, weird stuff happens on quadruple witching days.
A call owner may need to cover a short position right at the close today and exercising his April $233 calls is the only way to cover it.
There are thousands of algorithms out there which may arrive at some twisted logic that the calls need to be exercised.
And yes, calls get exercised by accident. There are still a few humans left in this market.
All of these fun and games happen right at the market close.
In the unlikely event that your April $233 calls ARE called away, this is what it will cost you.
Your SPDR S&P 500 ETF (SPY) April, 2017 $230-$233 in-the-money vertical bull call spread, which you bought for $2.63, is suddenly worth $3.00. You get to book an instant profit of $1,406.
Take out your short dividend loss of $3,925.85, and your total loss would come to $2,519.85 ($3,925.85 – $1,406 = $2,519.85). This is known as the expiration risk for the position.
But remember, the call owner would have to lose -$1,090.15 plus costs to inflict this on you.
If your calls ARE called away, this is what you do.
Call your broker and tell him you want to exercise YOUR $230 calls to meet the short position in the $233 calls. This is a perfect hedge and limits your risk to the $2,519.85 balance of the dividend payment.
This exercise process is now fully automated at most brokerages, but it never hurts to follow up with a phone call if you get an exercise notice. Mistakes do happen.
The fact that you still have a month of time value in the April $233 calls is what is protecting you from getting called away.
When you only have ONE WEEK to expiration, exercise becomes a much more serious problem. That is why I NEVER run very short dated SPY positions into quarterly ex-dividend dates.
If any of you are the slightest bit worried or confused by all of this, come out of your position RIGHT NOW! You should never be worried or confused about any position tying up YOUR money.
Professionals do these things all day long, and exercises become second nature, just another cost of doing business. If you do this long enough, eventually you get hit. I bet you don’t.
Another way to reduce your risk is to roll forward your position to the option expiration one week later (sell your April 21st expiring position and buy the April 28th position).
That way the extra one week of time premium makes it much more expensive for the April $233 owner to exercise against you.
SPY is the largest ETF in the world, currently with $226 billion in assets under management. The next two largest ETFs that track the S&P 500 are iShares’ IVV and Vanguard’s VOO—currently with $91 billion and $57 billion in assets respectively.
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