Money Due: Handling Credit Spread Assignment

Seeing a "Money Due" tag alongside red numbers in a Schwab account can induce a mild panic no matter how much experience a trader has. 

For those who trade options strategies like credit spreads enough, there may be a situation where the trade turns against them, the short leg gets assigned before the expiration date, and the trader has to buy stock they didn't plan to own. If their account doesn't have the funds available to make that purchase, they'll receive a margin call, and that Money Due tag will flash. What does this mean? A potential maximum loss—something every trader dreads. 

Remember, though, there's a reason to trade a credit spread: There's defined risk with this strategy. The goal of a credit spread is to make money by simultaneously selling a higher-premium option and buying a lower-premium option—of the same class and the same expiration, but typically a different strike price—and pocketing the difference as income. That way, if the higher-priced option gets assigned before expiration, the lower-cost one can limit the max loss. 

But that Money Due notification can sometimes make traders panic and think accepting the maximum loss is their only choice. However, there may be an opportunity to limit the loss on this trade even further if the long option still has extrinsic value. Let's walk through an example of getting assigned early and look at it economically. This exercise is for those who have experience trading options, so beginners should consider checking out our other educational content on the Learn tab of Schwab.com. 

Let's say a trader decided to place what's called a vertical put credit spread, or sometimes a bull put spread, on stock ZYX when it was trading at $120. This is a bullish strategy that consists of selling puts at one strike price and buying cheaper puts at a lower strike, with the hope that both puts expire out of the money (OTM) so the trader gets to keep the net credit. 

• Buy 10 ZYX 18 JUL 100 puts.
• Sell 10 ZYX 18 JUL 110 puts for a net credit of $4. 

 Let's review the trade's risk profile. 

When the trader sold the 10 put spreads, they were initially filled for a total credit received of $4,000 ($4 per  spread times the options multiplier of 100 times 10 contracts). This is the trade's max potential profit. The trade's risk, or max loss, is formulated from the difference between strikes (110 – 100 = 10) minus the credit received ($4) multiplied by the number of contracts (10) and options multiplier (100), which equals $6,000. 

• Max gain = $4,000
• Max loss = $6,000  

So, what's the scenario if the trader is assigned on the short (110 strike) put options? Let's say their position has gone against them with a week until expiration. ZYX is now trading well below the long strike at $88.50, and both puts are solidly in the money (ITM). The short put is assigned to the trader overnight, meaning they have to meet the obligation to buy 1,000 shares of ZYX at $110 each. 

That means the trader must have $110,000 in their account to cover the transaction, and they still have 10 open long 100-strike put options contracts. If their account does not have the $110,000 to cover the position, they'll receive a Money Due notification and need to take action. 

The trader has two approaches: Exercise the open long options, or close the options and liquidate the shares. Let's dive deeper into the two choices.

If the trader exercises the long put options to offset the stock position, they'd be facing max loss: 

• The assigned short put position cost $110,000 (110 strike x 100 x 10 contracts).
• By exercising the long put contracts, 1,000 shares of ZYX stock would be sold at the 100-strike price, giving them a credit of $100,000 (100 strike x 100 x 10 contracts).
• Because the trader received $4,000 from selling the 10 put spreads, total credit equals $104,000 and total debit equals $110,000.
• Result: $6,000 loss on the trade (excluding commissions and fees). 

But exercising is not the only choice. If there is time left until expiration, there may be extrinsic value, or the remaining value of the option due to time and implied volatility, which may have increased the options premium. 

Ultimately, the goal in this scenario is to minimize the losses for the position. Early assignment doesn't necessarily mean the trader has to exercise the contract to offset the assigned shares. There may be extrinsic value left in the options premium that may help minimize or reduce losses on the trade. 

To potentially capture the extrinsic value, the trader needs to know how far ITM the trade is. In the ZYX put credit spread, where ZYX was trading for $88.50, their long put option with a strike of 100 would be $11.50 ITM. Any additional premium is going to be any remaining extrinsic value. If the options premium is $12, the amount of extrinsic value in the option is $0.50. 

With ZYX trading at $88.50 and the 100-strike ZYX put option at $12, the trader was assigned on the 110-strike leg of the strategy and must purchase ZYX shares for $110,000. This time, however, instead of exercising the long put: 

• Sell the 1,000 shares at $88.50, bringing in $88,500.
• Close the long put options for $12, drawing in another $12,000.
• Because the trader received $4,000 from selling the 10 put spreads, total credit equals $104,500 and total debit equals $110,000.
• Result: $5,500 loss on the trade (excluding commissions and fees). 

The extrinsic value in the premium makes the difference in this scenario. By closing the position instead of exercising, the trader can capture $500 in extrinsic value from the option and reduce their max loss, making this the more economical decision. 

There is one final step to completing this process: placing the order. Remember, in some circumstances, the order may not fill at the mid-point, which can result in a price that is not economical. This can be attributed to wide spreads on the option that is deep ITM. Extrinsic value is calculated based on the mid-point and can be skewed when the spreads are wide. Traders should always make sure to double check their work and know where the order needs to fill to still be an economical trade.  

Assignment of an option can occur at any time, and while a Money Due alert can seem like a dire situation, remember to look at the position from an economic standpoint and look for opportunities to minimize losses. Traders have the right to exercise their long options but be sure to evaluate whether a covered trade with extrinsic value may be more economical. This is all about assessing risk and minimizing losses. And Schwab clients can always use the tools on thinkorswim or contact Trader Services to help think through their choices.