bull put spreads wrote:
Hi, Mark,

I've been writing a few covered calls, and am now interested in trying a put vertical spread.  I am considering writing
one that is out of the money.

I don't yet understand, though, what happens if my stock is between the legs and the put buyer exercises the option, or
if it is between the legs and the expiration date is reached.

Will the broker put the stock to me, using margined funds if I don't have sufficient funds?  Or will he exercise my other leg, even though it's out of the money ( I don't think so, I would have to tell him to do so, right)?

Naturally I don't want to lose my margin, and so I would set a stop loss order, but what if the stock dropped so fast
that it blew right through the short leg strike before the stop could be executed?

Hi Mary, 
Good questions - and I'm pleased that you are asking them before something unexpected happens to you. 
1) I believe you will be happier selling put spreads than you were writing covered calls. 
2) As an aside, if you use European style exercise (cannot be exercised prior to expiration day), cash-settled index options, such as SPX, NDX, RUT etc, then early assignment is never going to be a problem.  Assuming that you prefer to sell put spreads on individual stocks, then: 
a) If you are assigned an exercise notice, you are obligated to purchase stock at the strike price. So, yes, ths stock will be put to you.
b) No rational broker would exercise your other, out of the money, option to cover the stock.  But, please verify that your broker would never do that to you.
c) If you lack sufficient cash to pay for the stock, that's ok.  Your broker will lend the cash to you.  That means you will be using margin.  Of course, there is a limit as to how much you can borrow, and that depends on the size of your account.
d) Yes, if you want to exercise your long option, you must notify your broker.  You won't find yourself in this situation very often, but if your long put is fairly deep in the money, you might as well accept the loss and exercise.  It saves you the cost (interest charge) of carrying long stock.  If the put is not too deep in the money, you can hold and hope for a rally in the stock.
e) If the stock blows through your stop, a stop-loss MARKET order would still be executed, at the lower price.  However, a stop-loss LIMIT order would not get filled under the scenario you describe. You must also be certain as to what you mean by a 'stop loss order':  Would you sell stock short, or would your stop loss be an order to buy back the put you sold?  Or would it be an order to close the put spread?  Those are the three different types of stop-loss orders you can enter (assuming your broker accepts all types).  Please ask your broker if he allows all three. And if you elect to trade puts on the stop loss, you must choose between a market order and a limit order.  In general, it seldom pays to endter a market order, as you are likley to get a poor fill.  On the other hand, a limit order may not get filled.  And option prices change over time, so if you decide on a limit order, please recalculate the price you would be willing to pay (if using limits) at least weekly - and change your stop loss order, as necessary.
f) Don't expect to be assigned early if the stock drops below the strike price.  It does not pay for the put owner to exercise, unless the put is fairly deep in the money.  How far is 'fairly deep?'  A good estimate:  If the premium of the call option (same strike same expiration as the put) is less than the cost of carrying stock (interest charge on the cash from now through expiration), then it's possible the put owner will exercise.
g) Early exercise should not present much of a problem, but don't sell so many spreads that you would be unable to meet a margin call if assigned.  And you can prevent early assignment by using stop loss, rolling the spread, or closing to accept the loss. 
You are welcome and good luck with this program. 

Mark D. Wolfinger
Create Your Own Hedge Fund: Increase Profits and Reduce Risk With ETFs & Options