5 ms·

Yes, he could only lose as much as he bought for the contract price. I don't see how someone's cash balance should ever be affected by the strike price of an un

Yes, he could only lose as much as he bought for the contract price. I don't see how someone's cash balance should ever be affected by the strike price of an unexecuted contract. Can someone correct me?

bmh100 6y ago
It's just a weird thing that some online brokers seem to do. I once had exercised contracts for 200 shares put me "in debt" for $4mm. Then the shares settled, and everything in my account went back to normal.
greatjack613 6y ago
correct, unless he bought on margin, which should have triggered a margin call when he was unable to cover his position, but still unclear.
deleted 6y ago
[deleted]
meritt 6y ago
He had a spread. The short leg was assigned, the long leg cancels it out but it doesn't happen instantaneously. So he temporarily was on the hook for -300 $AMZN shares or whatever, which made his buying power massively negative. Then the long leg gets executed and it all evens out in the end for a relatively small profit or loss (the delta of the strikes), but that can be a nerve-wracking weekend if you don't understand the process. Robinhood's UI is not particularly informative in this process either.
- birdyrooster 6y ago
  The article says the account was not authorized for margin trading so how in the world could this even happen?
  - meritt 6y ago
    You don't need margin, you only need enough cash to cover the maximum loss, which is can be very small. e.g. right now if I wanted 3 put spreads on AMZN at 2640/2635 expiring this Friday, it would give me a net credit of about $2 per contract, or $600 credited to my account. My maximum loss would be 3 * 100 * (2640-2635) = $1500 minus the credit ($600) received, or $900. As long as I had a mere $900 in my account, this trade would be allowed. If I held through expiration and the short leg (AMZN $2640) was assigned, I would be contractually obligated to buy 300 shares of Amazon at $2640 a piece. This would briefly reduce my buying power by -$792,000. But as I also hold a contract to sell 300 shares of Amazon at $2635 ($790,500), it would have a net cost of only $1,500. And since I already received $600 up front, it would be just $900 additional out of pocket. But for a period of time, my account balance would have displayed -$792k.
deleted 6y ago
[deleted]
wallawe 6y ago
It happen when you use spreads. I have personally had this happen and it's jolting at first but is usually back to normal within hours. Here's how it works: 1. You sell a call credit spread. This is where you sell a call at say $100 and collect premium (let's use $2 for this example), then buy a call at $105 to cap your possible losses. 2. The options expire and the price of the stock is $110. I have lost the maximum amount. I sold a call and collected premium of $2, and bought a call at $105, so my total maximum loss was the difference ($3). 3. Robinhood will settle these assignment after hours, and will for whatever reason show the balance as if you hadn't bought the $105 call protection. So my balance may show a massive loss until the reconcile both the short and the long end of the calls. I have seen my balance go to -200k before when it was way in the positive before the day ended. This happened to be a Friday and it wasn't resolved until the markets opened the following Monday. Luckily, I realized what was going on, but many novice investors may not.
- cesarb 6y ago
  Could it happen that, due to some unusual circumstances, the call at $105 doesn't work, increasing your loss above the supposed maximum amount? For instance, what if the one who sold the call at $105 does not deliver the stock for some reason?
  - gen3 6y ago
    I think the risk of that instance is low, since options are a legally enforceable contract. I think the brokerage has some liability to pay the contract then get the money from their client, but I don’t have my Series 7 so take me with a grain of salt.
  - retzkek 6y ago
    There is so-called "pin risk," that could cause a larger loss than the "maximum". In this example, say the underlying closes at $102. The call you sold is ITM and is exercised, leaving you on the hook for 100 shares. However, the call you bought was OTM, so your broker won't exercise it for you, and you'd need to buy the shares at market to cover. However, you can't do that until the market opens on Monday. So if something happens that causes the stock to open substantially higher on Monday, you will be out whatever that difference is. Many traders will close their positions before market close, leaving a relatively tiny amount on the table to avoid the risk.

bmh100 6y ago

It's just a weird thing that some online brokers seem to do. I once had exercised contracts for 200 shares put me "in debt" for $4mm. Then the shares settled, and everything in my account went back to normal.

greatjack613 6y ago

correct, unless he bought on margin, which should have triggered a margin call when he was unable to cover his position, but still unclear.

deleted 6y ago

[deleted]

meritt 6y ago

He had a spread. The short leg was assigned, the long leg cancels it out but it doesn't happen instantaneously. So he temporarily was on the hook for -300 $AMZN shares or whatever, which made his buying power massively negative. Then the long leg gets executed and it all evens out in the end for a relatively small profit or loss (the delta of the strikes), but that can be a nerve-wracking weekend if you don't understand the process. Robinhood's UI is not particularly informative in this process either.

birdyrooster 6y ago
The article says the account was not authorized for margin trading so how in the world could this even happen?
- meritt 6y ago
  You don't need margin, you only need enough cash to cover the maximum loss, which is can be very small. e.g. right now if I wanted 3 put spreads on AMZN at 2640/2635 expiring this Friday, it would give me a net credit of about $2 per contract, or $600 credited to my account. My maximum loss would be 3 * 100 * (2640-2635) = $1500 minus the credit ($600) received, or $900. As long as I had a mere $900 in my account, this trade would be allowed. If I held through expiration and the short leg (AMZN $2640) was assigned, I would be contractually obligated to buy 300 shares of Amazon at $2640 a piece. This would briefly reduce my buying power by -$792,000. But as I also hold a contract to sell 300 shares of Amazon at $2635 ($790,500), it would have a net cost of only $1,500. And since I already received $600 up front, it would be just $900 additional out of pocket. But for a period of time, my account balance would have displayed -$792k.

deleted 6y ago

[deleted]

wallawe 6y ago

It happen when you use spreads. I have personally had this happen and it's jolting at first but is usually back to normal within hours. Here's how it works: 1. You sell a call credit spread. This is where you sell a call at say $100 and collect premium (let's use $2 for this example), then buy a call at $105 to cap your possible losses. 2. The options expire and the price of the stock is $110. I have lost the maximum amount. I sold a call and collected premium of $2, and bought a call at $105, so my total maximum loss was the difference ($3). 3. Robinhood will settle these assignment after hours, and will for whatever reason show the balance as if you hadn't bought the $105 call protection. So my balance may show a massive loss until the reconcile both the short and the long end of the calls. I have seen my balance go to -200k before when it was way in the positive before the day ended. This happened to be a Friday and it wasn't resolved until the markets opened the following Monday. Luckily, I realized what was going on, but many novice investors may not.

cesarb 6y ago
Could it happen that, due to some unusual circumstances, the call at $105 doesn't work, increasing your loss above the supposed maximum amount? For instance, what if the one who sold the call at $105 does not deliver the stock for some reason?
- gen3 6y ago
  I think the risk of that instance is low, since options are a legally enforceable contract. I think the brokerage has some liability to pay the contract then get the money from their client, but I don’t have my Series 7 so take me with a grain of salt.
- retzkek 6y ago
  There is so-called "pin risk," that could cause a larger loss than the "maximum". In this example, say the underlying closes at $102. The call you sold is ITM and is exercised, leaving you on the hook for 100 shares. However, the call you bought was OTM, so your broker won't exercise it for you, and you'd need to buy the shares at market to cover. However, you can't do that until the market opens on Monday. So if something happens that causes the stock to open substantially higher on Monday, you will be out whatever that difference is. Many traders will close their positions before market close, leaving a relatively tiny amount on the table to avoid the risk.