Option spreads, early exercise and other wrinkles

Updated: Jan 6th, 2011 | Vance Harwood | @6_Figure_Invest

A week ago Monday I created an IEF (iShares Lehman 7-10 Yr Treas Bond) bear spread in my Schwab margin account—with the short calls deep in the money at S90.   Several of the calls were assigned that night when IEF went ex-dividend ($0.248/share).  Since I wasn’t long IEF, this assignment resulted in a short position being created in my account.   I was surprised the calls were assigned since they don’t expire until January 22nd, but not unhappy collecting a small amount of premium early,  being shifted into a position with no more risk (the paired long calls were still in place), and more profit potential if IEF really drops.

On Wednesday I received a call from Schwab regarding the short position.   Evidently they had no IEF shares to loan to create the short position, so I was politely informed that I had two choices:

  • Work with them to try to borrow IEF shares from other brokers (some additional cost involved)
  • Close out the short position by the end of the week (which seemed like a generous amount of time)

I think it’s odd that a big player like Schwab doesn’t have a couple hundred shares of IEF available to short (overall short interest about 4.5%), but previously when I’ve checked, Schwab has always shown IEF in the “Hard to Borrow” category.

Rather than pay extra, I sold-to-open a couple S91 calls at 2.05 to collect a little bit more premium and bought IEF shares to cover the short.

An analogous situation can happen with option spreads in an IRA account if short calls are assigned or expire in the money, however in an IRA you can’t maintain a short position indefinitely, even if there were shares available to borrow—you have to cover the short.

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