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"What To Do When One Leg of Bull Call Spread Is Assigned?"



Question By Justsurf

"What To Do When One Leg of Bull Call Spread Is Assigned?"

What happens if you are assigned the short call on a Bull Call Spread? I have a bull call spread in VISA - Buy Jan75 call @ 3.80 and Sell Jan80 call @ 1.60. Let's say in the short term VISA stocks jumps to $83 and the Jan80 call gets assigned, what do you do? Do you need to exercise the long Jan75 call, buy the stocks (for $7500) and then sell it against the assigned short JAN80 call? Is there any way to address this situation without actually purchasing the stocks? i.e. sell/transfer the JAN75 Call and just Net the difference or something? Thanks!

Asked on 29 Oct 2009

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Answered by Mr. OppiE

Hi Justsurf,

Nothing breaks a multi-leg options trading strategy more than having one or more short leg assigned. Before you walk away with the idea that being assigned is a bad thing, it is not. When a short position is assigned, all extrinsic value in the contract evaporates in one shot, allowing you to make the full extrinsic value as profit without waiting until expiration. However, such an assignment may dramatically change the nature of a multi-leg options strategy.

If VISA rallies to $83 and the short Jan80 Calls get assigned, you would end up with a short 100 shares of VISA and long 1 contract of Jan75Call which creates a synthetic long put (Read our tutorial on Synthetic Positions). Compare the risk graph of a synthetic long put (which is the same as a long put) and the risk graph of a Bull Call Spread below:

long put risk graph Bull Call Spread risk graph

Yes, as you can see, the assignment transformed the position from a bullish options strategy into a bearish options strategy. If you are of the opinion that VISA is going to at least pullback for the short term after such a strong rally, then its ok to hold on to that resultant position but if you simply want to trade it as a Bull Call Spread, then you would have already attained its maximum profit potential as there is no more extrinsic value remaining on the assigned short call options and the long call options have already exceeded the strike price of the short call options.



In this case, to close off the position, you would have to close out both legs as individual trades. Sell To Close the Jan75Call (which will also allow you to salvage whatever is remaining of its extrinsic value. If you exercised it, you would have lost these extrinsic value as well) and then Buy 100 shares of VISA to close the short VISA position.

At this point, legging becomes important if you want to make sure that the profits made are not lost in the process of closing the position due to untimely execution.




In conclusion, when the short call options in your bull call spread is assigned, all you have to do is to close the position by closing out both legs as individual trades. Be sure to leg out of the position correctly to ensure preservation of profits.

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