I woke up to the following email from Interactive Brokers this morning:
Notification of Option Assignment
This communication serves to inform you that an assignment notice has been issued for the short option contracts held in [your account].
The email didn’t say which options were assigned, but I figured it was TLT since my calls were so deep in the money. When I looked at my account, I found only seven of my 10 TLT calls were assigned. This partial assignment means I’m short 700 shares of TLT at $130.00 (my short calls’ strike) and I still short three February $130 calls (which will be assigned in a few weeks unless a miracle drop in TLT hits). I have these short calls and short shares covered by 10 TLT February $132 calls. My long calls only have about $0.06-0.07 in time value, so I wouldn’t gain much by selling them now, unless I wanted to exit my full position.
I had a plan ready to execute when the options expired and I think I’m going to wait until closer to then to make my next trade. I considered selling seven puts at the February $129 or $130 strike to try to make a little extra money while the position idles. Instead, I opted to stay patient and try to work for a better profit.
I could make thousands of dollars on this position if it acts anywhere close to how I think it will. Based on the price right now of $137.70, I could sell my 10 TLT February $132 long calls (excluding all time value) for $5.70. Since I paid $1.212 for each call in December, I could make $4.47 ($4,470 for 10 calls) after commission. I’ll take a profit on the short calls too. I sold the 10 February $130 calls for $1.692 and when all 10 are assigned, the short calls will increase my cost per share I shorted, essentially giving me $1,685 (after commission) in gains. Added together, $130 (short price) plus $4.47 (long calls profit) plus $1.685 (short calls profit) equals a cost per share of roughly $136.15. None of this would be a profit if I had to buy back my shares at $137.70, but I don’t think I’ll have to.
I expect TLT to drop back into the $120s this year. If I get out at $130, I’ll make a $6.15 profit per share. With 1,000 shares short, I could make $6,150. However, short shares are required to pay out dividends that the long shareholders receive. So, every month I’m short, I’ll have to pay about $280-290 in dividends and I’ll also be at risk for TLT to push higher.
I’ll use options to combat both of these risks. If I sell far out of the money puts, I can cover the costs of the dividends while still allowing plenty of room to the downside to profit when TLT falls. In case TLT pushes higher, I’ll need to buy a vertical call spread. Originally, I didn’t think TLT had a high probability to finish the contracts’ life above $130. Now, I don’t think TLT will drop that much by then. When TLT started to run higher, I thought it would max out at $135, but it hit $138.50 on Friday, proving how easy it is to be wrong when the world’s central banks are pouring cash into the markets.
Since I can manage near-term price movements and dividend payouts fairly easily, my biggest risk is that TLT hangs at levels around $137-138 for a long time with little volatility. I’ll lose money every time I buy a call spread that doesn’t work out for me. Luckily, TLT is rarely flat for long. It should continue its climb or start to drop within a few months. By waiting another couple of weeks while I have my February calls as a hedge, I can try to get a feel for how TLT will move in the coming months. Ideally, TLT will continue to run higher while I have my current hedge and I won’t have to buy a wide call hedge for April (I’m thinking of going two months out, but could go as far out as September). If TLT is in the upper $130s at February expiration, I’ll have more profit available on a slide and less room to lose on a further drop in yields (increase in TLT’s price).
Everyone knows that bond prices will drop eventually, but nobody knows when. At least for now, I can’t lose any more money on TLT until after February 20. That thought alone will allow me to sleep easily while I debate my next move. I have to decide what strike puts to sell and what strikes to buy for my call spread. In another couple of weeks, I might decide not to push for a big profit, but to just try to get out without losing my shirt. If TLT has another huge spike, I might try to time it by selling my long calls at a higher profit, but that would be a big risk.
How would you work it?