stock option call spread?

Question

hi guys let say we buy eem 20 month expire 130 strike and we sell 140 strike front month and front month expire in the money what we have to do thank you

Answer 1

Since there is almost no chance that the short call will "expire in the money" I am assuming you mean the short call is "in the money close to expiration" instead.

You do not "have to" do anything at this time, although there is a good chance you want to do one of the following:

(1) Roll out (roll forward) the short call. Use a spread order to "buy to close" the front month $140 strike and "sell to open" a later month $140 strike.

(2) Roll the short call up and out. Use a spread order to "buy to close" the front month $140 strike and "sell to open" a later month higher strike. This allows you to collect more "time premium" and makes a larger profit if the underlying continues to go up, but adds additional risk if the underlying goes down significantly.

(3) Roll the short call up and out and the roll long call up. This is, IMHO, usually a less attractive choice but it does allow you to realize some of the profit from the increase in value of the long call.

(4) Simply close both positions and realize whatever profit or loss exists at this point.

Regardless of what, if anything, else you decide to do, use this trade as a learning experience. Diagonal spreads are usually most profitable when the volatility of the underlying is less than expected. Big moves in the price of the underlying usually cause losses. You are usually better off making adjustments before there have been big price moves. At the time you open a diagonal spread you should have already decided what adjustments you will make, and when you will make them, if the price of the underlying does not behave as you expected it would when you opened the spread.

Addendum:

The answer "the sold call options will be exercised, so you need stocks to cover them. You must exercise the long call options to get the stocks." is probably very poor advice.

A call option with 19 months before expiry will almost certainly still have some "time premium" (extrinsic value) which you would be giving away if you exercised it. For example, if the stock was at $160 and the premium for the call option was $37, there would be $7 per share "time premium" built into the option price. If you exercised the call you would buy 100 shares for $13,000. If you bought the shares on the open market for $160 per share and sold the option for $37 per share your net cost for buying the stock would be ($160 - $37) = $123 per share or $12,300 for 100 shares. By exercising the option you would be giving away $700.

If you do receive an assignment on the short call, and your account is large enough, you have another alternative as well. You can simply maintain the short position for some time to wait to see what happens to the stock price. If the stock price goes up you can still exercise the long call at a later time to cover your short stock position. If the stock prices goes down you can cover the short stock position by purchasing the shares on the open market then reestablishing another diagonal spread by selling another short-term call option.