Comment by wallawe | Hacker News Reader

Comment by wallawe | Hacker News Reader

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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.

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?

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.

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.

That's a really good point. I'm pretty sure Robinhood exercises behind the scenes for you on the day of expiration 30-60 mins prior to close to avoid this.

The article says the account was not authorized for margin trading so how in the world could this even happen?

What I just described doesn't require margin. Spreads are "defined risk" trades so as long as you have enough in your account to cover your max potential loss, you are fine to make the trades.

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