I’ve recently received a few emails from readers asking how to repair their credit spreads or iron condors. In some cases their short strikes had been breached. Given the unprecedented rally we’ve been experiencing, it’s not hard to believe that most of these issues have been on the call side.
Generally when someone emails with this kind of issue, there’s not a lot that can be done. It’s very hard to adjust a position when it has gone in the money.
Let’s say you sell a call spread for $1.50, then price rises and breaks through your short call and the spread is now trading for $10.00. That’s a pretty big loss you have to try and cover if you roll.
Try to never let your short strikes get touched, a good rule of thumb is to adjust if the delta of your short option hits +/- 0.30. At that point you can still salvage the trade, but after that, it’s a crapshoot.
hi, Gavin
What other criteria do you think besides you mentioned that delta of our short strike price hit 0.3 or less.
What action do we need to save or defend our short strike on the option spread?
1) Buy back the short strike on spread but how much of losses we need to pay for the buy back. Normally if we sell credit spread we only collect about 20% or less for strike price within 1 to 2 Standard deviation out from the current price. If the stock price moves against us or short or long sides went ITM, we should just close out both of them on the safe side to avoid exercise or assign with stocks we don’t want.
2) what are the best choice on call side or PUT side if the spreads are ITM?
Hi Lawrence,
There are a couple of different strategies that I use and it depends on the situation.
1) If the spread rises by 200% I adjust or close. So if you sell a spread for $1, adjust when it hits $3.
2) Never, ever, ever let your credit spreads go in the money. There is not much you can do once that happens.
Hi, Gavin
I had made some credit spread that went ITM and got assigned before the expiration day. Some times, the loses got more than the theoretical lose. Example. If I sold credit spread for $0.30 for $ 1 spread strike, on paper I will lose $0.70 but in reality I lose $0.73 to $0.78.
Can you explain why when the short strike went ITM, the sellers of option sold me the short PUT strike ITM prior to expiration. Also why the loses can be more than theoretical calculation for losses when the short strike went ITM?
Hi Lawrence,
Perhaps it is the cost of the assignment that made the loss bigger than the possible loss?
In terms of the puts being exercised, if the short put is ITM and there is little or no time value left, you are at risk of having them exercised prior to expiry. This article might help you:
https://www.thinkorswim.com/tos/displayPage.tos?webpage=lessonExercise