Lost $30,000 on a $1-Wide Credit Spread (Options Traders MUST Watch This)

the other day i was in contact the other day i was in contact about 30 000 from shorting one dollar wide credit spreads five times and in this video we are going to talk about exactly how that happened which is a devastating sequence of unfortunate events but everybody who is in the options trading world needs to see this because this can save you thousands and thousands of dollars in the future through an unnecessary mistake that could happen to anybody including me normally it is understood that if you sell or short an option and the option is out of the money at the time of expiration meaning if you sell a put option with a strike price of 100 and the stock price is at 105 on the friday of expiration that means your 100 put expires worthless right well initially it would seem that that's the case but there's actually something very important that you should understand and that we need to talk about today which is that options can be exercised up to an hour and a half after the closing bell on the day of expiration and let's talk about exactly what happened to this trader's position and how they ended up losing thirty thousand dollars as opposed to their initial maximum loss potential of less than five hundred dollars this person had these short put spreads in tesla that expired on friday september fourth and they shorted the 410 puts and bought the 409 puts and therefore they shorted the 410 409 put credit spread and they did that five times now since this is a one dollar wide credit spread the maximum potential value of these spreads at expiration if they are fully in the money is one hundred dollars a piece and if they short five of the spreads that means the maximum potential value of that position is 500 and when we account for the credit that they received initially that means the maximum loss potential should be less than 500 but here's what happened on friday september 4th tesla shares closed around 418 dollars per share and at first glance that means that if the 410 409 put spread is expiring and tesla shares closed at 418 dollars per share then that means those put spreads should have been worthless and that trader should have been left with the full profit on their position but unfortunately that is not what happened so let's talk about what happened next so at 3 pm central time the stock market closes and at 3 pm central time tesla shares closed around 418 dollars per share and this trader had assumed that the 410 409 put spread would have gone out worthless leaving them with the maximum profit potential so the market closes at 3 p.m central and at 4 16 central or an hour and 16 minutes after the market had closed on this expiration friday or for this weekly cycle i should say tesla shares had tanked and they were trading well below 410 dollars per share which was the short put strike price of this traders put spread and what happened was the trader got assigned on their 410 puts an hour and 16 minutes after the market had closed but i know you're wondering how could this person have been assigned if it was an hour and 16 minutes after the market closed and the stock price had closed at a level that left the put spread out of the money how were they assigned well according to the options industry council website option exchanges have a cutoff time of 4 30 pm central for receiving exercise notices and so with 14 minutes left to spare before the option exchanges need to receive these exercise notices tesla shares went from 418 and fell way below 410 and this person that was watching their long 410 puts they saw that they had become pretty far in the money and with 14 minutes to spare until they had to get the exchange their exercise notice they exercised their 410 puts and for the trader in question here since they were short the 410 409 put spread they were assigned on all five of their short 410 puts and therefore they purchased 500 shares of tesla at 410 which is a stock position of 205 000 in value but by the time that this trader was notified that they had been assigned on their 410 short puts it was way later in the day and i believe they said it was around midnight and if it's at midnight and after 4 30 pm central that means the 409 put that they owned could no longer be exercised and since the stock price had closed at 4 18 and they did not exercise the option after hours that means the 409 put that they owned which should have protected against any losses below 409 those puts had literally expired worthless and since it was after the exercise cut-off time they could no longer use those options and so what happened to this trader is that they are left with 500 shares of tesla at 410 dollars per share representing a stock position with a value of 205 000 and this trader had an account of around 30 000 so they were about six to seven times leveraged in that scenario and after the long weekend had ended and the market opened up on tuesday tesla shares were trading somewhere around 350 to 355 dollars per share and the brokerage firm automatically liquidated their share position in tesla which means they sold their 500 shares at around 350 per share and since they purchased those 500 shares at 410 per share that means their loss on each share was 60 and if we multiply a 60 share price loss times 500 shares we get a loss of thirty thousand dollars so essentially what happened is this trader lost one hundred percent of their trading account using a five lot or five contracts of a one dollar wide credit spread which as i've said multiple times in this video has a maximum potential value of 500 but because the stock price had closed out of the money but in the hour and 15 minutes after the market closed the share price tanked they actually got assigned on their short puts because they were actually in the money after hours and it was totally within the boundaries of options trading mechanics for the opposing trader to exercise those 410 puts once they had become in the money but by the time the trader was notified about this position that they had been assigned on the short 410 puts the market had closed and it was already after the exercise note is cut off and therefore the 409 puts that they owned were worthless because the stock price had closed at 418 dollars and so basically they got assigned on the 410 puts five times buying 500 shares at 410 but by the time they were notified the 409 put was officially expired worthless and they could no longer use it which means they were left with a 205 000 stock position that when the market opened on the next tuesday which was after the long holiday weekend the share price was down 60 per share and with the traders inability to hold this position since it was way too large of a stock position to hold given their account size the brokerage firm which any brokerage firm would do this they liquidated their share position because they have to control the risk on their side and unfortunately for this trader that meant a 30 000 loss stemming from a very conservative put spread position that only had a maximum loss of less than 500 so when i started interacting with this person i felt absolutely horrible because this was just a devastating series of unfortunate events that could have happened to anybody it could have happened to me and i just i have to make this video because i need to get this information out there because we need to talk about the solution for this problem and how you can avoid this in the future so it's a very simple solution and the solution is to close any short options that you have before they expire if the stock price moves in a way where the short out of the money option becomes in the money after hours it's almost certain that you will be assigned on that and i know i did a video a couple months ago called why traders should almost never exercise options but that video was mostly concerned with exercising options before expiration and i made that video to alleviate fears of early assignment risk which means being assigned on an in the money short option before it expires because in that scenario options usually have lots of extrinsic value in their prices and if they are exercised the person who exercised the option will lose the extrinsic value and they would never do that intentionally and for that reason that's why in the money options are rarely exercised unless they have very little extrinsic value but at expiration or in the hour after expiration an option will not have any in extrinsic value and therefore exercising the option is actually a very smart thing to do and in this case where the option initially expired out of the money but became in the money after hours it is a very intelligent decision to exercise the option because then you're actually getting back value from that option that initially would have been worthless given the stock price at the time of the closing bell so this is a very very specific area of options trading and unfortunately it can cause extreme losses as we've seen in this video so i felt an obligation to make it to protect everyone in the future including myself because at the end of the day if you have an out of the money option at expiration and you're short that option you should always close it before expiration because you never know what happens after hours and if you're not paying attention something very unfortunate could happen to you as did in this story so if you found this video informative and helpful please give it a like and share it with your options trading friends so that we can get this information out to more and more people and we can save people from thousands and thousands of dollars of losses and potentially even save lives by helping people avoid unnecessary account blow-ups in the future through this devastating sequence of unfortunate events that can happen after expiration my name is chris and i will see you all next time [Music] is

Channel: projectfinance

Views: 225,348

Rating: 4.944468 out of 5

Keywords: 30000 loss on 1-wide credit spread, huge options trading losses, options trading mistakes, credit spread options strategy, credit spread options, options trading, trading, stock options, finance, stock market, options trading for beginners, options expiration, exercise options after expiration, chris butler, projectoption, credit spreads weekly options

Id: rtVFj9nRRDo

Length: 11min 10sec (670 seconds)

Published: Sat Sep 12 2020

Reddit Comments

[u/Jesta23]

11minute video to explain something that should have taken 1minute tops.

[u/colonel701]

His opposing party exercised the 5 debit puts 1.5 hours after market closed. Why isn’t his own debit puts auto exercised as well?

[u/Yoyocuber]

3 points

1. No one in this group should have spreads open on the day before/day of expiration if they’re not far OTM

2. In general if y’all follow theta principles then you should be closing spreads 1 week before expiration because as exp approaches then gamma effect increases and now ur playing direction and not time

3. Extremely narrow spreads are not a good move because commissions eat you up fast.

[u/SadDragon00]

Always close your positions before expiry guys. The risk of assignment just isn't worth the couple extra bucks of profit.

[u/Hippoatropurpureus]

Close at 50% profit, knuckleheads.

[u/Fibonotme1]

The max profit had been reached well before market close and should’ve been closed out. Having left this play open after market close, especially on a Friday was dumb. Know what you’re doing when trading options.

[u/ScottishTrader]

Yet another example of why ALL options should be CLOSED and not let to expire!!

This is all the trader's fault for letting the position open and being ignorant on how they work . . .

[u/MarcusElden]

Ironically if he was assigned and the market went favorably, he would have made a ton of money. These situations can work in your favor as well.

[u/PHXHoward]

Don't hold short options until expiration people.