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Morning Mailbag – 1/8/15

January 8, 2015

By | 3 Comments

Welcome Back! I get a lot of questions via Twitter, Facebook, email and other methods of communication. The morning Mailbag is a way for me to share my answers to those questions with the Tackle Trading community. What’ I’ve found as a mentor is that if one student has a question, its a good bet that 10 others have a similar question.

From George:

Hi Tim:

As a learning experience, I would like to receive your feedback on the following situation.
During Earning Season, I had placed an Inverted Butterfly on SBUX as a Weekly option (4 days until Earnings which was to occur on the upcoming Friday). The stock had made a small gap, but there some more profit in the trade. So I held through earnings and I left the trade on until Monday, because it was still moving for me and I was making more profit according to the Risk Graph. On Monday, I decided that I would wait one more day and close the Inverted Butterfly on Tuesday and take the profits at that time. On Tuesday when I logged into which was around 1:15 PM, my Inverted Butterfly had been turned into a Stock trade with -200 shares. Fortunately, this is a virtual account, because for me to close these -200 shares of stock on SBUX, the cost including commissions is $16,379.99.

Questions:
1.Can you tell me why the Inverted Butterfly would be converted into shares of stocks?
The only thing that comes to mind is that I got Assigned the stock. Could I have possibly been Assigned when I was still making a profit?
2. If this is the solution, what could I have done to not be Assigned?
3. Is there anything that I can do now; since I own -200 shares of stock, to reduce the cost (or risk) before closing this trade down?
Thank you for your help and assistance.
Sincerely,
George

George,

Thanks for your question. I will also post this answer to the blog @ tackletrading.com as I believe people can learn from it.

Inverted Butterfly’s are advanced options strategies that include selling 1 leg, buying more contracts at the center leg, and then selling another leg. The rules are taught in Rich Dad Educations Elite Options class. The situation you describe is interesting to say the least. Lets lay down a few basics:

1. options rarely will be assigned or exercised by the market before expiration. But, it does happen.
2. Traders tend to think they know they details of their trade but often miss key details. For me to give you a 100% accurate answer I’d need to look at your trade log and confirm the details. For the purpose of this answer, I’ll assume you’re giving me accurate information.
3. If an option is assigned, that’s rarely the reason a trade wins or loses. A trade wins or loses because the underlying stock price, volatility or time moved adversely to the profit zones in the risk graph for the position.
4. If assignment does happen, the trade transfers what would be option risk, to stock risk. This includes margin and cost as well.

Here’s a chart from the Earnings SBUX reported last:

sbux INV BFLY

 

Now, I’ve read your email many times.  It doesn’t seem that you’ve identified which strikes you bought and sold.  This would be a key bit of information.  If the strikes were deep in the money then they are at higher risk of assignment.  Strikes above .95 delta are at the most risk of early assignment because all of the extrinsic value has been sucked out of the chain.  The only reason the InvBfly would be converted to stock is if it was deep ITM, if you actually sold the expiration that happened the Friday of earnings and held through expiration on accident or if there was a mistake in virtual.  I’ve seen all of these happen, but most likely its the 1st or 2nd scenario.
Yes you can be assigned on a profitable trade.  In fact, the reason your trade was profiting is that the stock moved past your breakevens on the risk graph and moved all options in the money – most likely.  If you hold options that are in the money into expiration they would be assigned.  If you want to get out of that risk in advance then you need to exit your trade pre-expiration.  You probably should have just taken the profit when you had it on Friday.  If you’ve held this trade this long short -200 shares of stock.  I’d be very curious to here why.  Did you think the stock would drop over time?  When a mistake happens in your account, the best thing to do is correct it right away and either exit it, plan it out like its a new trade or hedge it.  Hopefully this helps.  Thanks again for your question!

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3 Replies to “Morning Mailbag – 1/8/15”

  1. I’m trying to get into the Mailbag blog but it wont give me access,yet i can get access to earlier blogs.Any suggestions
    Is anyone else having this issue
    Thanks

  2. Tim Justice says:

    Hi Matt!

    The mailbag is part of the regular blog. I used to do it once or twice a week, and I’m going to be bringing it back. If you have questions you can twitter them to me @timjusticeutah or email us team@tackletrading.com

    Warm Regards,

    Tim

    1. Tim its working now
      .Mailbag is a great idea

      Thanks

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