Accepting Exposure   • 223
they own rather than trade them away for a profit. Recall from Chapter 2  
that experienced option investors do not do this most of the time; they 
know that because of the existence of time value, it is usually more beneficial 
for them to sell their option in the market and use the proceeds to buy the stock 
if they want to hold the underlying. Inexperienced investors, however, often are 
not conscious of the time-value nuance and sometimes elect to exercise their 
option. In this case, the exchange randomly pairs the option holders who wish 
to exercise with an option seller who has promised to sell at that exercise price.
There is one case in which a sophisticated investor might chose to 
exercise an ITM call option early, related to a principle in option pricing 
called put-call parity. This rule, which was used to price options before 
advent of the BSM, simply states that a certain relationship must exist be-
tween the price of a put at one strike price, the price of a call at that same 
strike price, and the market price of the underlying stock. Put-call parity 
is discussed in Appendix C. In this appendix, you can learn what the exact 
put-call parity rule is (it is ridiculously simple) and then see how it can be 
used to determine when it is best to exercise early in case you are long a 
call and when your short-call (spread) position is in danger of early exercise 
because of a trading strategy known as dividend arbitrage.
The assignment process is random, but obviously, the more contracts 
you sell, the better the chance is that you will be assigned on some part or all 
of your sold contracts. Even if you hold until expiration, there is still a chance 
that you may be assigned to fulfill a contract that was exercised on settlement.
Clearly, from the standpoint of option sale efficiency, an ATM call is the 
most sensible to sell for the same reason that a short put also was most efficient 
ATM. As such, the discussion that follows assumes that you are selling the 
ATM strike and buying back a higher strike to cover.
In a call-spread strategy, the capital you have at risk is the difference be-
tween the two strike prices—this is the amount that must be deposited into 
margin. Depending on which strike price you use to cover, the net premium 
received differs because the cost of the covering call is cheaper the further 
OTM you cover. As the covering call becomes more and more OTM, the ratio 
of premium received to capital at risk changes. Put in these terms, it seems 
that the short-call spread is a levered strategy because leverage has to do with 
altering the capital at risk in order to change the percentage return. This con-
trasts with the short-call spread’s mirror strategy on the put side—short puts—
in that the short-put strategy is unlevered.