As much confidence as I have in The Wheel Strategy, I am always slightly worried about getting assigned. Therefore, this article will explain the steps you can take to avoid getting assigned and what to do in the specific situation that you do get assigned shares.
Steps for Trading The Wheel Strategy
When trading The Wheel Strategy, you should know that there are three easy steps:
- Sell Puts and collect Premium.
- If you do not get assigned shares, move back to Step 1. If you get assigned then move on to Step 3.
- Step 3: Sell Calls and collect Premium.
Step 2 is the point in The Wheel Strategy where you can potentially get assigned shares. And this is where you might be thinking: “What if I don’t want to get assigned? What are my possibilities there?” And this is exactly what we’re going to talk about today.
Worried About Getting Assigned Using The Wheel Strategy
I am actually going to share with you a very specific example from my own trades. As I am writing this, it is Friday, and unfortunately some of the put options that I have right now might get assigned.
Let’s use this trade as an example and I will show you what other possibilities I have if I don’t want to get assigned. So let’s get started!
So remember Step 2 of The Wheel Strategy? You may get assigned if the stock dips below the strike price of the put that you sold. Remember, if you’re not getting assigned, it’s okay, no big deal! You just go back to step number one, rinse and repeat.
Now, if you do get assigned, just skip ahead to Step 3 where you sell call options.
However, there will be a rare situation where it looks like you will get assigned. I know what you’re thinking: you obviously do not want to get assigned, so how do we avoid this?
I want to show you three solutions here, and in order to do this, I want to show you a very specific trade that I made involving a stock called Tapestry (NYSE:TPR).
Assignment Example: My Tapestry Trade
So this is Tapestry.
As you can see, a few days ago, I sold the $37.00 put option with an expiry date of April 8th, which happens to be today. So the put option for Tapestry is expiring today and we have another 25 minutes until the markets close for the week.
I sold these Tapestry put options for $40.00 per contract in premiums. TPR is trading at $33.42 right now. So right now, this put contract is deep in the money, and since there is only about 25 minutes left to trade, it looks like I’m about to get assigned.
As you know, this means that I will have to buy 100 shares of Tapestry at $37.00 per share for each put contract I own.
Since TPR is trading at $33.42, it means I am immediately in the hole for this trade. This price is also slightly too far away from the assigned price so I won’t be able to sell a call option to hedge out of this trade.
So what can I do in this situation? For the experienced traders out there, you’ll already know I have three things I can do. The first option I can do if I do not want to get assigned is to just simply close the trade. Let’s see what this looks like in the PowerX Optimizer.
Scenario 1: Closing the Trade
This is the calculator in the PowerX Optimizer program. So for this trade, I sold the Tapestry put option for a premium of $0.40 or $40.00 per contract.
Now let’s say that I want to get rid of this option contract. Just to review this specific trade, this is where I sold TPR: the $37.00 puts with an expiry date of April 8th for $0.40 per option.
So these calculations are based on this account size, which is currently sitting at $250,000 in cash, which gives me a total combined buying power of $500,000. I can realistically trade 27 of these Tapestry put contracts and still be okay.
Now we’ve arrived at option number one: I could just close out this trade. I’ll show you what this would look like if you ever come across this situation during a trade.
In order to do this, I’ll just head over here to my brokerage account so we can take a look at the TPR put option.
So the $37.00 put option that I bought is going to expire in the next 20 minutes or so, and I’ll be assigned these shares. The first thing I can do to get rid of this contract is to buy it back.
In your brokerage account, this is the Buy to Close option. Now if I select Buy to Close 27 put option contracts for the $37.00 strike price, the bid spread is $3.40 over $3.70, and the last trade price is $3.60.
What Does This All Mean?
So what exactly does all of this mean? I am buying it back, meaning I do not want to get assigned these shares, so I am effectively canceling out the original trade.
From this, we can see that I can buy it back for $3.60 which was the last trade price. Since I sold the put option for $0.40, I am taking a $3.20 loss on the trade.
Keep in mind, that this loss is not just $3.20, it is $3.20 multiplied by 27 option contracts. So if we do the math, it’s actually a loss of $8,640, or ($320 x 27 put contracts). Remember, this is only in the specific scenario where we do not want to own these assigned shares.
This isn’t ideal, is it?
So you’re probably thinking this is not an ideal scenario, because this trade resulted in a rather large loss. If we take a look back a the TPR chart and zoom out, we can see that over the last two years TPR has had solid support at the $37.00 price level. This is why I sold the $37.00 put contracts.
But of course, there is always the chance that it falls below that, which is what happened here. Once a stock loses that long-time support level, it could potentially fall much lower. Sometimes it is best to just close out the trade and take the loss.
An $8,640 loss is always a scary thought, but remember, this is a specific trade from my own trading account. If you are dividing this loss by $250,000, we’re only talking about a 3.5% loss. Numbers and figures are relative, so one losing trade should never be devastating for your account.
Scenario 2: Rolling the Trade
Alright so let’s talk about our next scenario for this trade: rolling the put option. What exactly does rolling the trade mean? Basically, we are buying back this expiring put option and at the same time, selling next week’s put option for the same stock.
At this point in the trade, we are hoping that TPR will bounce back next week.
Overall, if we were to look at the performance of the broader markets, the S&P 500 has been going downhill and the NASDAQ has been hit even harder.
We know as traders, there is a good chance we see a market rebound next week and TPR can bounce back. Rolling the trade forward helps us to avoid assignment for another week.
How to Roll Your Trade Forward
Switching back to my brokerage account here, I am going to select a Multi-leg trade for TPR’s put option contracts. Once again I will be Buying to Close this week’s $37.00 put options, but at the same time, I will be Selling to Open another 27 of the $37.00 put options for TPR for next week.
Now, look what happens when I select these two legs of the Multi-leg trade. This is the net quote. There is a debit of $0.10 and a credit of $0.30. This means we can probably collect $0.10 for this trade, so we cannot collect any more premium here. All this does is ensures that we avoid assignment for another week.
I’ll explain in a moment of why you might want to avoid assignment in general, but let’s continue with the next step in rolling your trade.
When I buyback this week’s expiring contracts and sell next week’s for the same strike price, we receive a net credit of $0.20 which as we know, is actually $20 per contract. At $20 per contract for 27 contracts, we can make $540 just by holding for another week.
Now, this is $540 in additional premium, so I’m going to mark this in the green as a net gain. In the end, not a bad way to salvage a losing trade! Let’s talk about our third scenario!
Scenario 3: Do Nothing and Get Assigned
This scenario is pretty straightforward: do nothing at all, and get assigned those shares of TPR once the markets close for the week. I mentioned before that I would talk about the reasons why you might want to avoid assignment. Here’s why:
There are two main reasons to avoid getting assigned from a losing trade:
- You just don’t like the stock anymore so you don’t want to be stuck with shares
- You sold too many contracts and don’t have enough buying power
Reason 1: “I don’t like the stock anymore”
These things can happen! When you sold the put on TPR, you liked how the chart looked. But now, a week later, after falling below the support line you might not like TPR as much as you did before.
This is totally normal. If this is the case, then why would you want to get assigned? Simply use Scenario 1 from above and close out the trade at a loss.
Reason 2: You don’t have enough buying power
Reason 2 is when you realize that maybe you shouldn’t have sold that many TPR put contracts. Let’s do some simple math to see how much we would owe our brokerage on that TPR trade.
We have 27 put option contracts at a $37.00 strike price. This means we will be assigned the shares at this $37.00 price.
The math on this is (27 contracts x $37.00) x 100 shares per contract, which comes to $99,900. That is a lot of buying power that will be tied up in this one trade.
Of course, you might be saying, “I don’t have that much buying power!”. We shouldn’t have traded that many contracts in the first place. If this is the situation, then you can choose either Scenario 1 or Scenario 2.
You Can’t Predict the Future
We can close the trade at a smaller loss and move on, or we can roll the trade forward to next week and try to recapture a small gain.
Of course, if TPR continues to fall next week, you would see an even larger loss. But if the stock bounces back, we can we could be sitting at a smaller loss and then roll the put option again next week.
If we have a debit at this point, you might need to give back some of the credit you received. But this is definitely more favorable than being assigned those shares.
You Need to Always Have a Plan!
So what is my plan here? What did I do in this specific TPR trade? It might surprise you, but I took the assignment of the shares.
Why did I decide to take assignment after providing reasons why you should avoid it? Because my plan from the beginning was that I liked the stock!
Always do your research into a stock before making the trade. I liked Tapestry because I think it is a solid value stock. Let me show you what I mean here, I’m going to head over to Google Finance and pull up the TPR underlying details.
So you see, take a look at this PE ratio: 11.27. That’s very reasonable for the company, especially since it pays a 3.0% dividend yield as well! That is not bad at all.
If you bring up their financials, the quarterly revenue is very stable as well.
If we zoom out we can see there seems to be some cyclical seasonality with Tapestry, which makes sense for a retail brand. We see it had a pretty good year in 2020 given the circumstances.
Most companies had a loss that year so it shouldn’t be surprising to see a slight dip in any stock’s chart. But looking at 2021, Tapestry was back at pre-pandemic levels so overall it seems like a very stable company!
Let’s Review Your Options
So that’s why I am okay taking assignment with TPR shares. It’s a great stock and I think it will bounce back over time. What I really wanted to do was show you the different options you have if you want to avoid taking assignment.
Let’s just review here:
- Close out the trade for a loss.
- Roll the trade over to next week.
- Take the assignment of the shares.
The important lesson here is that you really need to have a plan in case things go sideways. The markets have been volatile lately so you never know what might happen to a trade. Even a solid value stock like TPR fell below its support.
And that’s another thing: Pick good value stocks. You should know the fundamentals of the company and know the stock you are trading.
Here is a video that shows you exactly how I find my value stocks. All I showed you here was searching for a stock in Google Finance, but the hyperlinked video goes into more detail.