Real-World Trading: The Diagonal Spread, Part 2

Because there is perceived risk between the sold option and the purchased option of 10 points, your broker will probably want margin to cover this risk. However, this margin should be offset by the initial credit. Let's assume the stock gets a boost from the merger's approval and we get assigned on our short 65 call. Let's say the stock is trading for $80, so we'd have to sell 100 shares of stock to the exerciser for $65 a share.

We'd need to go out into the open market and buy 100 shares at $80, totaling $8,000. The theoretical price of the Sep03 75 call would be about $9.25, plus we initially got $3.30. Thus, we would still have a profit, even though we were assigned. This is why the break-even point is so high.

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