Assigned Option Contract Case Study

For some reason, many traders fear being assigned option contracts as part of an option strategy. Maybe it's the large capital requirement to hold the shares, or perhaps it’s the "unknown" around how to manage the position. Like most things in life, when you slow down and take the time to walk through the position and the mechanics, it becomes much more manageable.

On today's show, I want to once again provide another case study on how we managed a recent assignment on our GLD iron butterfly position. It was fun for me to go back through my own comments and remarks during this 4-month trade, and I have no doubt that you'll also find it extremely helpful. We'll take you through each and every step from the initial trade entry, adjusting and inversion, being assigned shares, selling covered calls, etc. No detail will be left out as we'll walk through the P&L calculations together, step by step. Let's begin.

Overview

In this case study, GLD did not do anything that we had predicted.
However, with adjustments, we turned what would have been a $748 loss into a $16 profit.

Case Study: Assigned Options Contract in GLD

Our initial position in GLD was the 121 centered iron butterfly - selling the $121 calls, the $121 puts on June 22, 2018.
On the call side, we bought the $128 options, and on the put side, we bought the $114 put options for protection.
We kept our position size small, selling two contracts.
Total credit taken in on initial position was $3.13
On June 22, GLD was already at the bottom of a two-month move lower, down from $128.
GLD continued the downslide for another two and a half months until it reached a low of $111.

June 22: Trade Commentary

"Adding a new position in GLD for August today. The ETF has reached our technical oversold level, and so, I think there's a good chance it either rallies or stops falling from here. Hence, we are slightly bullish in tilt, and our iron butterfly centered at $121, just slightly above where the stock is trading. This is our first of a couple planned entries in GLD."

Inverted Adjustment

We reached a point where we decided the trade was no longer in a position to roll for a credit.
We went into defensive mode and decided to go inverted on the position to try to collect as much credit as possible.
Adjusting iron butterflies is very hard on the outside because the short strikes are at the same price point - the $121 strike price.
The only way to adjust is to simply go inverted, moving the call strike down below the short put strike for an inversion.
By August 8, GLD had moved from $121 down to $114.5, continuing to fall with almost no rallies.

August 8: Trade Commentary

"For our GLD position in August, it doesn't look like we can close or be able to roll this position to the next month. So, the next best thing right now is to work on reducing the risk or loss if GLD stays lower. Here we are starting to get more aggressive and rolling down our furthest out $121 calls to go inverted for a credit. At this point, I expect to take a loss on this position overall. So now the mission is reduction of the loss via the inverted strategies and credits."

When we went inverted, we closed our $121 call options, which now were far out of the money and practically worthless at this point.
We sold much closer $115 call options that were just slightly above where the stock was trading at the time.
The net credit that we took in was a $65 credit. We added on to the initial $313 credit.

Options Assigned

On August 16, we were assigned our short $121 put options.
At this point, GLD was trading at $111, down $3 from when we went inverted.

August 16: Trade Commentary

"We were assigned on GLD $121 puts and are deciding to hold the shares long for now and sell covered calls against them. Reason being, as mentioned in the video update last night, GLD has moved parabolically lower and is showing again, more technical buy signals. Now, these signals we used from our research have been very good during stock assignments like this over the last two years, and so I will continue to trust these signals. We will now remove the other legs that were needed in the next alerts coming up."

At this point, the stock was going parabolic--no longer a slow, mediocre decline.
Most of the time, when a stock starts going parabolic, it's going to snap back, or it's going to stop that decline.
Assignment does NOT mean that someone on the other side is a smarter trader than you or knows something you don't.
Just because they have other insights does not mean the market will react the way they think it will react.
At this point, we got another technical buy signal.

Two options:

Dump the position and take a $748 loss.
Hold the contracts long and still work with the position.

On the same day, we also had an opportunity to cash in on some protection that we had originally bought.
We were able to sell back the $114 put options we had bought for 18 cents, and we sold them back for an additional credit of $248.
The only reason why this worked is that our position size was small enough to handle the stock assignment.

August 16: Trade Commentary

"The other position in August we need to close are the long $114 puts we had had on for protection originally. While they did their job and made their money, it was not enough to curb the loss on the short call strikes, but it kept us in a defined risk position. Now since they have value left and are in the money, we're selling them back to the market and removing the position before expiration. From here, the only other remaining contracts we have in August are out of the money call options, which will expire worthless."

We have now liquidated everything in our account for GLD and are left with 200 shares of long stock at $121 for the shares.
At this time, right after expiration, when we've closed everything, we were looking at an effective break-even point on the actual shares of stock, including all of the credits we had taken in from options selling, of $114.74.
Total credits at that point were $626.
Options selling activities were able to reduce the effective price on those stock shares by $6.26.

Selling Covered Calls

Since we held long shares, we knew that we also should be selling covered calls against them to collect more premium, reducing the cost basis on the shares even below the $114.74.
On August 21, as the stock was slowly starting to go up, we sold the $115 call options for September for a $73 credit.
Now we are looking at an effective share price of $114.01 after incorporating the additional credit into our break-even price.

August 21: Trade Commentary

"Note: This alert is only for those we were assigned long gold shares as we were last month. As planned, we've been expecting a little bit of a slight bounce in gold prices before selling a covered call on our stock. Today, I think we start the process by selling two calls at roughly the 30 Delta short strike to cover our 200 shares of stock. The premium is decent, and there's a little bit of wiggle room for GLD to still move higher."

After that point, for the next month and a half, GLD traded absolutely dead sideways.
At September expiration, our $115 call option expires totally worthless.
We ended up selling another $115 call option for October expiration for a net price of $65.
Our new adjusted cost basis on the shares was then $113.36.
In early October, GLD moved down again to $112, so we rolled down our covered call strike to collect more premium.
October 8, we bought back our $115 call options and rolled them down to the $113 call options. These were just above where GLD was trading at the time, and we collected an additional credit of $45.
This reduced the cost basis on the shares to $112.91.
Two trading days later, GLD had a massive move higher up to $116.

Closing the Position

On October 19, we sold back the stock for $116 and bought back our now in the money $113 call options.
We earned a net credit of $112.99, taking an $8 profit on the entire position after all adjustments.
We were able to break down the cost basis on the shares that we were assigned by staying mechanical, extending the trade, and keeping our position size small.
We took a position that was $748 in the red and turned it into a profit.

Conclusion

No doubt, this was a very long trade to hold.
If you are able to extend the duration of a trade and be patient, you can end up winning.
However, those who were not patient and did not hold on lost more money.
As you stick to your rules and stay mechanical, you can change a losing trade into a profit.