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Understanding assignment risk in Level 3 and 4 options strategies
E*TRADE from Morgan Stanley
With all options strategies that contain a short option position, an investor or trader needs to keep in mind the consequences of having that option assigned , either at expiration or early (i.e., prior to expiration). Remember that, in principle, with American-style options a short position can be assigned to you at any time. On this page, we’ll run through the results and possible responses for various scenarios where a trader may be left with a short position following an assignment.
Before we look at specifics, here’s an important note about risk related to out-of-the-money options: Normally, you would not receive an assignment on an option that expires out of the money. However, even if a short position appears to be out of the money, it might still be assigned to you if the stock were to move against you just prior to expiration or in extended aftermarket or weekend trading hours. The only way to eliminate this risk is to buy-to-close the short option.
- Short (naked) calls
Credit call spreads
Credit put spreads, debit call spreads, debit put spreads.
- When all legs are in-the-money or all are out-of-the-money at expiration
Another important note : In any case where you close out an options position, the standard contract fee (commission) will be charged unless the trade qualifies for the E*TRADE Dime Buyback Program . There is no contract fee or commission when an option is assigned to you.
Short (naked) call
If you experience an early assignment.
An early assignment is most likely to happen if the call option is deep in the money and the stock’s ex-dividend date is close to the option expiration date.
If your account does not hold the shares needed to cover the obligation, an early assignment would create a short stock position in your account. This may incur borrowing fees and make you responsible for any dividend payments.
Also note that if you hold a short call on a stock that has a dividend payment coming in the near future, you may be responsible for paying the dividend even if you close the position before it expires.
An early assignment generally happens when the put option is deep in the money and the underlying stock does not have an ex-dividend date between the current time and the expiration of the option.
Short call + long call
(The same principles apply to both two-leg and four-leg strategies)
This would leave your account short the shares you’ve been assigned, but the risk of the position would not change . The long call still functions to cover the short share position. Typically, you would buy shares to cover the short and simultaneously sell the long leg of the spread.
Pay attention to short in-the-money call legs on the day prior to the stock’s ex-dividend date, because an assignment that evening would put you in a short stock position where you are responsible for paying the dividend. If there’s a risk of early assignment, consider closing the spread.
Short put + long put
Early assignment would leave your account long the shares you’ve been assigned. If your account does not have enough buying power to purchase the shares when they are assigned, this may create a Fed call in your account.
However, the long put still functions to cover the position because it gives you the right to sell shares at the long put strike price. Typically, you would sell the shares in the market and close out the long put simultaneously.
Here's a call example
- Let’s say that you’re short a 100 call and long a 110 call on XYZ stock; both legs are in-the-money.
- You receive an assignment notification on your short 100 call, meaning you sell 100 shares of XYZ stock at 100. Now, you have $10,000 in short stock proceeds, your account is short 100 shares of stock, and you still hold the long 110 call.
- Exercise your long 110 call, which would cover the short stock position in your account.
- Or, buy 100 shares of XYZ stock (to cover your short stock position) and sell to close the long 110 call.
Here's a put example:
- Let’s say that you’re short a 105 put and long a 95 put on XYZ stock; the short leg is in-the-money.
- You receive an assignment notification on your short 105 put, meaning you buy 100 shares of XYZ stock at 105. Now, your account has been debited $10,500 for the stock purchase, you hold 100 shares of stock, and you still hold the long 95 put.
- The debit in your account may be subject to margin charges or even a Fed call, but your risk profile has not changed.
- You can sell to close 100 shares of stock and sell to close the long 95 put.
Long call + short call
Debit spreads have the same early assignment risk as credit spreads only if the short leg is in-the-money.
An early assignment would leave your account short the shares you’ve been assigned, but the risk of the position would not change . The long call still functions to cover the short share position. Typically, you would buy shares to cover the short share position and simultaneously sell the remaining long leg of the spread.
Long put + short put
An early assignment would leave your account long the shares you’ve been assigned. If your account does not have enough buying power to purchase the shares when they are assigned, this may create a Fed call in your account.
All spreads that have a short leg
(when all legs are in-the-money or all are out-of-the-money)
Pay attention to short in-the-money call legs on the day prior to the stock’s ex-dividend date because an assignment that evening would put you in a short stock position where you are responsible for paying the dividend. If there’s a risk of early assignment, consider closing the spread.
However, the long put still functions to cover the long stock position because it gives you the right to sell shares at the long put strike price. Typically, you would sell the shares in the market and close out the long put simultaneously.
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Everything You Need to Know About Options Assignment Risk
By Pat Crawley
The fear of being assigned early on a short option position is enough to cripple many would-be options traders into sticking by their tried-and-true habit of simply buying puts or calls. After all, theoretically, the counterparty to your short options trade could exercise the option at any time, potentially triggering a Margin Call on your account if you’re undercapitalized.
But in this article, we're going to show you why early assignment is a vastly overblown fear, why it's not the end of the world, and what to do if it does occur.
What is Assignment in Options Trading?
Do you remember reading beginner options books or articles that said, "an option gives the buyer the right, but not the obligation, to buy/sell a stock at a specified price and date?" Well, it's accurate, but only for the buy side of the contract.
The seller of an option is actually obligated to buy or sell should the buyer choose to exercise their contract. So when options, assignment is when you, the lucky seller of an options contract, get chosen to make good on your obligation to buy or sell the underlying asset.
Let's say you sold a call option on a stock with a strike price of $50, which you held until expiration. At expiration, the stock trades at $55, meaning it's automatically exercised by the buyer. In this case, you are forced to sell the buyer 100 shares at $50 per share.
So when selling options, assignment is when you, the lucky seller of an options contract, get chosen to make good on your obligation to buy or sell the underlying asset.
What is Early Assignment in Options Trading?
Early assignment is when the buyer of an options contract that you're short decides to exercise the option before the expiration and begins the assignment process.
Many beginning traders count early assignments as one of their biggest trading fears. Many traders' fear of early assignment stems from their lack of understanding of the process. Still, it's typically not something to worry about, and we'll show you why in this article. But first, let's look at an example of how the process works.
For instance, say we collect $1 in premium to short a 30-day put option on XYZ with a strike price of $45 while the underlying is trading at $50. Fast forward, and it's the morning of expiration day. Options will expire at the close of trading in a few hours. The underlying stock is hovering around $44.85. Our plan pretty much worked as planned until, for some reason, the holder of the option exercises the option. We're confused and don't know what's going on.
It works exactly the same way as ordinary options settlement . You fulfill your end of the bargain. As the seller of a put option, you sold the right to sell XYZ at $45. The option buyer exercised that right and sold his shares to you at $45 per share.
And now, let's break down what happened in this transaction:
- You collected $1 in premium when opening the contract
- The buyer of the option exercises his right to sell at $45 per share.
- You’re now long 100 shares of XYZ that you paid $45 for, and you sell them at the market price of $44.80 per share, realizing a $0.20 per share loss.
- Your profit on the transaction is $0.80 because you pocketed $1 from the initial sale of the option but lost $0.20 from selling the 100 shares from assignment at a loss.
Why Early Assignment is Nothing to Fear
Many beginning traders count early assignments as one of their biggest trading fears; on some level, it makes sense. As the seller of an option, you're accepting the burden of a legitimate obligation to your counterparty in exchange for a premium. You're giving up control, and the early assignment shoe can, on paper, drop at any time.
Exercising Options Early Burns Money
People rarely exercise options early because it simply doesn't make financial sense. By exercising an option, you're only capturing the option's intrinsic value and entirely forfeiting the extrinsic value to the option seller. There's seldom a reason to do this.
Let's put ourselves in the buyer's shoes. For instance, we pay $5 for a 30-day call with a strike price of $100 while the underlying is trading at $102. The call has $2 in intrinsic value, meaning our call is in-the-money by $2, which would be our profit if the option expired today.
The other $3 of the option price is extrinsic value. This is the value of time, volatility, and convexity. By exercising early, the buyer of an option is burning that $3 of extrinsic value just to lock in the $2 profit.
A much better alternative would be to sell the option and go and buy 100 shares of the stock in the open market.
Viewed in this light, an option seller can’t be blamed for looking at early assignment as a good thing, as they get to lock in their premium as profit.
Your Risk Doesn’t Change
One of the biggest worries about early assignment is that being assigned will somehow open the trader up to additional risk. For instance, if you’re assigned on a short call position, you’ll end up holding a short position in the underlying stock.
However, let me prove that the maximum risk in your positions stays the same due to early assignment.
How Early Assignment Doesn’t Change Your Position’s Maximum Risk
Perhaps you collect $2.00 in premium for shorting an ABC $50/$55 bear call spread. In other words, we're short the $50 call for a credit of $2.50 and long the $55 call, paying a debit of $0.50.
Before considering early assignment, let's determine our maximum risk on this call spread. The maximum risk for a bear call spread is the difference between the strike minus the net credit you receive. In this case, the difference between the strikes is $5, and we collect a net credit of $2, making our maximum risk on the position $3 or $300.
You wake up one morning with the underlying trading at $58 to find that the counterparty of your short $50 call has exercised its option, giving them the right to buy the underlying stock at $50 per share.
You'd end up short due to being forced to sell the buyer shares at $50. So you're short 100 shares of ABC with a cost basis of $50 per share. On that position, your P&L is -$800, the P&L on a $55 long call is +$250, on account of you paying $0.50, and the call being $3.00 in-the-money. And finally, because the option holder exercised early, you get to keep the entire credit you collected to sell the $50 call, so you've collected +$250.
So your P&L is $300. You've reached your max loss. Let's get extreme here. Suppose the price of the underlying runs to $100. Here are the P&Ls for each leg of the trade:
- Short stock: -$5,000
- Long call: +$4,450
- Net credit received from exercised short option: +$250
- 5,000 - (4,450 + 250) = $300
While dealing with early assignments might be a hassle, it doesn’t open a trader up to additional risk they didn’t sign up for.
Margin Calls Usually Aren’t The End of the World
Getting a margin call due to early assignment isn't the end of the world. Believe it or not, stock brokerages have been around for a long time. They have seen early assignments many times before, and they have protocols for it.
Think about it intuitively, your broker allowed you to open the short option position knowing that the capital in your account could not cover an early assignment. Still, they let you make the trade anyways.
So what happens when you get an early assignment that you can’t cover? Your broker issues you a margin call. Once you’re in violation of their margin rules, they pretty much have carte blanche to handle the situation as they wish, including liquidating the assigned stock position at their will.
However, most brokers will give you some time to react to the situation and either decide to deposit more capital, liquidate the position on your own, or exercise offsetting options to fulfill the margin call in the case of an option spread.
Even though a margin call isn't fun, remember that the overall risk of your position doesn't change due to an early assignment, and it's typically not a momentous event to deal with. You probably just have to liquidate the trade.
When Early Assignment Might Occur?
One of the few times it might make sense for a trader to exercise an option early is when he's holding a call that is deep in-the-money, and there's an upcoming ex-dividend date.
Because deep ITM calls have very little extrinsic value (because their deltas are so high), any negligible extrinsic value is often outweighed by the value of an upcoming dividend payment , so it makes sense to exercise and collect the dividend.
Deep In-The-Money Options Near Expiration
While it's important to emphasize that the risk of early assignment is very low in most cases, the likelihood does rise when you're dealing with options with very little extrinsic value, like deep-in-the-money options. Although, even in those cases, the probabilities are pretty low.
However, an options trader that is trading to exploit market anomalies like the volatility risk premium, in which implied volatility tends to be overpriced, shouldn't even be trading deep-in-the-money options anyhow. Profitable option sellers tend to sell options with very little intrinsic value and tons of extrinsic value.
Don't let the fear of early assignment discourage you from selling options. Far worse things when shorting options! While it's true that early assignment can occur, it's typically not a big deal. Related articles
- Can Options Assignment Cause Margin Call?
- Assignment Risks To Avoid
- The Right To Exercise An Option?
- Options Expiration: 6 Things To Know
- Early Exercise: Call Options
- Expiration Surprises To Avoid
- Assignment And Exercise: The Mental Block
- Should You Close Short Options On Expiration Friday?
- Fear Of Options Assignment
- Day Before Expiration Trading
- Accurate Expiration Counting
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The Risks of Options Assignment
Any trader holding a short option position should understand the risks of early assignment. An early assignment occurs when a trader is forced to buy or sell stock when the short option is exercised by the long option holder. Understanding how assignment works can help a trader take steps to reduce their potential losses.
Understanding the basics of assignment
An option gives the owner the right but not the obligation to buy or sell stock at a set price. An assignment forces the short options seller to take action. Here are the main actions that can result from an assignment notice:
- Short call assignment: The option seller must sell shares of the underlying stock at the strike price.
- Short put assignment: The option seller must buy shares of the underlying stock at the strike price.
For traders with long options positions, it's possible to choose to exercise the option, buying or selling according to the contract before it expires. With a long call exercise, shares of the underlying stock are bought at the strike price while a long put exercise results in selling shares of the underlying stock at the strike price.
When a trader might get assigned
There are two components to the price of an option: intrinsic 1 and extrinsic 2 value. In the case of exercising an in-the-money 3 (ITM) long call, a trader would buy the stock at the strike price, which is lower than its prevailing price. In the case of a long put that isn't being used as a hedge for a long stock position, the trader shorts the stock for a price higher than its prevailing price. A trader only captures an ITM option's intrinsic value if they sell the stock (after exercising a long call) or buy the stock (after exercising a long put) immediately upon exercise.
Without taking these actions, a trader takes on the risks associated with holding a long or short stock position. The question of whether a short option might be assigned depends on if there's a perceived benefit to a trader exercising a long option that another trader has short. One way to attempt to gauge if an option could be potentially assigned is to consider the associated dividend. An options seller might be more likely to get assigned on a short call for an upcoming ex-dividend if its time value is less than the dividend. It's more likely to get assigned holding a short put if the time value has mostly decayed or if the put is deep ITM and close to expiration with a wide bid/ask spread on the stock.
It's possible to view this information on the Trade page of the thinkorswim ® trading platform. Review past dividends, the price of the short call, and the price of the put at the call's strike price. While past performance cannot be relied upon to continue, this information can help a trader determine whether assignment is more or less likely.
Reducing the risk associated with assignment
If a trader has a covered call that's ITM and it's assigned, the trader will deliver the long stock out of their account to cover the assignment.
A trader with a call vertical spread 4 where both options are ITM and the ex-dividend date is approaching may want to exercise the long option component before the ex-dividend date to have long stock to deliver against the potential assignment of the short call. The trader could also close the ITM call vertical spread before the ex-dividend date. It might be cheaper to pay the fees to close the trade.
Another scenario is a call vertical spread where the ITM option is short and the out-of-the-money (OTM) option is long. In this case, the trader may consider closing the position or rolling it to a further expiration before the ex-dividend date. This move can possibly help the trader avoid having short stock on the ex-dividend date and being liable for the dividend.
Depending on the situation, a trader long an ITM call might decide it's better to close the trade ahead of the ex-dividend date. On the ex-dividend date, the price of the stock drops by the amount of the dividend. The drop in the stock price offsets what a trader would've earned on the dividend and there would still be fees on top of the price of the put.
Assess the risk
When an option is converted to stock through exercise or assignment, the position's risk profile changes. This change could increase the margin requirements, or subject a trader to a margin call, 5 or both. This can happen at or before expiration during early assignment. The exercise of a long option position can be more likely to trigger a margin call since naked short option trades typically carry substantial margin requirements.
Even with early exercise, a trader can still be assigned on a short option any time prior to the option's expiration.
1 The intrinsic value of an options contract is determined based on whether it's in the money if it were to be exercised immediately. It is a measure of the strike price as compared to the underlying security's market price. For a call option, the strike price should be lower than the underlying's market price to have intrinsic value. For a put option the strike price should be higher than underlying's market price to have intrinsic value.
2 The extrinsic value of an options contract is determined by factors other than the price of the underlying security, such as the dividend rate of the underlying, time remaining on the contract, and the volatility of the underlying. Sometimes it's referred to as the time value or premium value.
3 Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.
4 The simultaneous purchase of one call option and sale of another call option at a different strike price, in the same underlying, in the same expiration month.
5 A margin call is issued when the account value drops below the maintenance requirements on a security or securities due to a drop in the market value of a security or when buying power is exceeded. Margin calls may be met by depositing funds, selling stock, or depositing securities. A broker may forcibly liquidate all or part of the account without prior notice, regardless of intent to satisfy a margin call, in the interests of both parties.
Just getting started with options?
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Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled Characteristics and Risks of Standardized Options before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.
With long options, investors may lose 100% of funds invested.
Spread trading must be done in a margin account.
Multiple leg options strategies will involve multiple commissions.
Commissions, taxes and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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The assignment risks of writing call and puts – covered or not.
Dec 22, 2020
Writing options, which is also called selling options, alone or as part of a covered strategy, has unlimited risk potential in your account when writing a call option, and the maximum risk for writing a put is if the stock price goes to zero, which could cause a significant loss. As the writer of an option, you have certain obligations you must fulfill, and these obligations are out of your control while you maintain an open short options position.
When you write a call option, you take on the obligation to deliver long stock to the call buyer at the contract strike from the time of sale until the expiration date. For this obligation, you collect an option premium from the buyer at the current option price (less costs of the trade), which is your maximum gain on this position. The maximum risk here is unlimited, the stock can go to the moon, and you are on the hook for the entire journey.
When you write a put option, you take on the obligation to deliver short stock to the put buyer at the contract strike at any time from the time of sale until the expiration date. For this obligation, you collect an option premium from the buyer at the current option price (less the costs of the trade), which is your maximum gain on this position. The maximum risk here is unlimited for writing a call option, and when writing a put option the risk is limited to the stock going to zero, but this floor can still result in a significant loss.
Benefits of Writing Call and Put Options
Generally, writing options have two main benefits and purposes: (1) to capture the option premium time value as the option decays on the way to expiration; and (2) to reduce the cost of putting on a directional long call or put trade. Writing calls and puts and buying calls and puts in combinations allow you to trade many different market outlooks – bullish, bearish, low volatility, high volatility, and others.
The Risks of Writing Call and Put Options
First, most brokers require that you have some options trading experience before your account is approved to write options, and you will also be required to maintain a minimum account balance. You should always make sure that you have enough money to cover the initial margin and should consider an additional cushion amount for a reasonable move against the position and to deliver the stock position if assigned. Always check with your broker regarding minimum capital requirements.
Second, there is assignment risk throughout the life of the trade for American-style options. Typically, options are assigned only when they are deep in-the-money, or when there is an advantage to exercising to capture a stock dividend (see “Dividend Considerations” below). Still, an option writer can be assigned anytime up until expiration.
Finally, writing options generally requires a margin account, but you can also write a cash-secured put in a cash account that covers the full value of the options position.
You can never really tell when you will be assigned. Once you write an American-style option (put or call), you have the potential for assignment, to receive (and pay for) or deliver (and are paid for) shares of stock. In some circumstances, you may be assigned on a short options position while the underlying shares are halted for trading, or perhaps while they are the underlying company is the subject of a buyout or takeover.
To ensure fairness in the distribution of option assignments, the Options Clearing Corporation (OCC) utilizes a random procedure to assign exercise notices to clearing member accounts maintained with the OCC. The assigned firm must then use an exchange-approved method (usually a random process or the first-in, first-out method) to allocate notices to its clients’ accounts that are short the options.
An option buyer holding a call or put has the right to exercise that option at any time to take delivery of the long (Call) or short stock (Put). The option writer is always at risk of early assignment at any time through expiration for American-style options.
There are several types of assignment risk factors you should understand:
- In-the-money early exercise a. Dividend considerations
- Exercise at expiration a. After-hours trading b. “Do not exercise”
In-The-Money Early Exercise
The chance of early assignment happens most often when the options are in-the-money (ITM), and although it is unlikely, even an option that is out-of-the-money (OTM), under certain circumstances, could be assigned at expiration.
Credit Spread early assignment example – in-the-money exercise XYZ stock is currently trading at $80 per share. Two weeks ago, you put on a credit spread when XYZ was trading at $92 per share. You wrote 1 95 put for $5 and bought 1 90 put $2.50 for a credit of $2.50, or $250. Both options are now in-the-money, and the 95 put you wrote is assigned to you, and to offset that assignment, you exercise your 90 Put. You are flat, out of the position, but also incur a number of fees and may have some price risk before all is said and done.
If you are writing a call option in a spread on a stock that pays a dividend, there is additional assignment risk if the call option is in-the-money and/or has less extrinsic (time value) than the dividend payout.
This is a good time to remind you that there can be a lot of moving pieces in an options trade. You should be aware of several factors if you are writing call options on a stock that pays a dividend including: the amount of the dividend, the ex-dividend date, and the impact the upcoming dividend payment may have on the price of the stock and the option premium.
If you are assigned short stock just prior to ex-dividend date, you will be responsible for paying the dividend. So, it may not be worth the trouble here. You may want to close or roll forward any short in-the-money call positions well in advance of any ex-dividend date.
Exercise at Expiration
At expiration, the buyer of an option is in control and can exercise at any time prior to the cutoff time on Friday expiration. If you hold short options, calls, or puts, into and through expiration, bad things could happen that are out of your control even if those options are out-of-the-money.
Keep in mind that most stock options stop trading at 4:00 pm ET when the regular stock market session closes, but many stocks continue to trade after hours until 8:00 pm ET, even on expiration Friday, which may affect the intrinsic value and possibly the decision of a call or put option buyer to exercise an option, as exercise can take place hours after the market has closed on expiration Friday.
Credit Spread after-hours assignment example at expiration – out-of-the-money exercise It is expiration Friday, and the markets just closed. XYZ stock is currently trading at $96 per share. Two weeks ago, you put on a credit spread when XYZ was trading at $92 per share. You wrote 1 95 put for $5 and bought 1 90 put for $2.50, for a credit of $2.50, or $250. Both options expire out-of-the-money worthless, and you expect to collect your $250 profit. However, for some unknown reason, the buyer of a 95 put exercises, and you are selected and assigned the long stock. Your covering 90 put option has expired, leaving your new long stock exposed to the market, and over the weekend, the CEO of XYZ is arrested for embezzlement, and XYZ opens Monday at $50.00 per share, creating an unrealized loss in your account of $4,000 on that 1-contract position.
Do Not Exercise (DNE)
An option buyer may give his broker the instructions to “Do Not Exercise” at expiration regardless of the in-the-money value of the option. Why would someone just give away that money? Typically, this can happen when an option is slightly out-of-the-money at the close of the session on the expiration date, and there is a chance the option value will rise in the aftermarket session. Often, “Do Not Exercise“ instructions are given to the broker if the option buyer does not have enough money in their account to take delivery of the exercised stock.
“Do Not Exercise“ can be a problem for an option writer as the contract is voided. The voided contract is assigned to a random option seller of that contract.
Credit Spread assignment example at expiration – in-the-money – do not exercise It is expiration Friday, and the markets just closed. XYZ stock is currently trading at $89.00 per share. Two weeks ago, you put on a credit spread when XYZ was trading at $92 per share. You wrote 1 95 put for $5 and bought 1 90 put for $2.50, for a credit of $2.50, or $250. Both options are now in-the-money, and you expect to lose $250 on the trade. However, a put buyer somewhere does not have enough money in his account to exercise their put option, so before the 5:30 pm deadline on expiration day, he informs his broker – “Do Not Exercise”; this will cause him to lose the $600 ($6 per share $95-$89). The OCC designates an options writer to offset this non-exercised put, and that contract is voided. However, you were counting on that short 95 put contract to offset your long 90 put, but there is now no short put any longer in your account, and you are auto-exercised on the long 90 put and must short the 100 shares of XYZ stock, and you are now exposed to the XYZ price action open on Monday.
Will I Get Assigned?
You can never really tell when you will be assigned. Once you write an American-style option (put or call), you have the potential for assignment, to receive (and pay for) or deliver (and are paid for) shares of stock. In some circumstances, you may be assigned on a short option position while the underlying shares are halted for trading, or perhaps while they are the subjects of a buyout or takeover.
To ensure fairness in the distribution of option assignments, the Options Clearing Corporation (OCC) utilizes a random procedure to assign exercise notices to clearing member accounts maintained with OCC. The assigned firm must then use an exchange-approved method (usually a random process or the first-in, first-out method) to allocate notices to its client’s accounts that are short the options.
Writing calls and puts even as part of a limited risk type spread can be high-risk strategies going into expiration and are not appropriate for every trader or every account.
And although the strategy of writing options is often to have the options expire worthless, you need to stay keenly aware of all the circumstances that can affect your position as it approaches expiration. There are a lot of moving pieces here, and you need to be aware of all of them.
So, based on all of the factors and risks, there may be times when closing a short options position prior to expiration, to avoid and assignment risk, may be the right call. It may cost you some profits, but it will reduce your stress and eliminate any further risk and the chance of an unexpected loss.
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How Option Assignment Works: Understanding Options Assignment
May 26, 2023 — 08:00 am EDT
Written by [email protected] for Schaeffer ->
Options assignment is a process in options trading that involves fulfilling the obligations of an options contract.
It occurs when the buyer of an options contract exercises their right to buy or sell the underlying asset. The seller (writer) of the options contract must deliver or receive the underlying asset at the agreed-upon price (strike price).
What is Options Assignment?
Options assignment can happen when the owner of an option exercises their right to buy or sell shares of stock or when options expire in the money (ITM). This process can be complex and involves various factors such as the type of option, expiration date, and market conditions.
There are two main styles of options contracts: American-style and European-style. American-style options allow the buyer of a contract to exercise at any time during the life of the contract. In contrast, European-style options can only be exercised on the expiration date.
Traders selling American-style options are at risk of assignment anytime on or before the expiration date. While they can technically be assigned anytime, the option must be ITM for the owner of the contract to benefit from exercising their right.
On the other hand, many options traders prefer to sell European-style options as it is impossible to be assigned before the expiration date, giving them more flexibility to hold their contract without worrying about being assigned early.
Who is at Risk of Assignment in Options Trading?
Traders with short options positions are at risk of assignment because they have sold the option and are obligated to deliver or receive the underlying asset. If the owner of the options contract decides to exercise their rights, the seller of the options contract must fulfill their obligations.
Traders with long options positions are not at risk of assignment as they are in control of exercising their options. A long option holder has the right, but not the obligation, to buy or sell the underlying asset at the strike price. If the long option holder decides not to exercise their options, they can let the options contract expire worthless.
What is the Risk of Assignment?
The risks associated with options assignment are primarily centered around the obligations of the seller of the options contract. If the holder of the options contract decides to exercise their right to buy or sell the underlying asset, the seller must fulfill their obligations.
For example, if a trader sold a put option with a $100 strike price, and the stock dropped to $90, they would still have to buy the stock at $100 per share. When an option is ITM, it generally indicates that the seller of the option is in an unfavorable spot.
Of course, if you sold a $100 strike put option when the stock was trading at $120, and now it is trading at $90, the seller is likely regretting their original trade. However, it is impossible always to time the market perfectly, and assignment risk is the risk option sellers must assume.
Traders must be aware of market conditions that could increase the risk of assignment, such as large price movements in the underlying asset. Option selling strategies benefit from a stable market environment, so you must ensure the stock you are trading will remain stable until the expiration date. Events that may cause significant market volatility, such as earnings, are crucial to be aware of when selling options.
How to Avoid Option Assignment
While it may not be possible to avoid options assignment completely, there are several strategies that options traders can use to reduce the likelihood of being assigned.
One strategy is to manage short options positions by closing the position if your strike gets tested. For example, if you sold a $100 strike put when a stock is trading at $120 per share, you can avoid assignment by closing the position before the stock drops under your strike price of $100.
Another strategy is to roll over your option, which means you close it out and simultaneously sell a new contract with a different strike price and/or date. Traders can roll their contracts to the same strike price at a further date or even roll it down or up to ensure their contract stays out of the money (OTM).
These strategies may not always be effective in avoiding assignment. Traders should always be prepared to fulfill their obligations if they are assigned and have a plan to manage their positions accordingly. If a stock moves hard overnight, there is no guarantee you will successfully avoid assignment.
Do You Keep the Premium if You Get Assigned?
Yes, if you get assigned on a short options position, you still keep the premium you received initially. However, it is important to note that if you are assigned, you will also be obligated to fulfill the contract terms by buying or selling the underlying asset at the strike price. This means you may incur additional costs associated with fulfilling your obligation, such as purchasing the underlying asset at an unfavorable price.
What Happens When Your Covered Call Gets Assigned?
If a covered call gets assigned, the seller of the call option must sell the underlying stock at the strike price to the buyer of the call option. The seller will still be able to keep the premium received from the sale of the call option.
For example, if you own a stock at $100 per share and sell a $130 strike call option, you will be forced to sell if the stock is above $130 on the expiration date. Additionally, you can be assigned before the expiration date if the stock is trading above your strike price.
While the covered call seller will still generate a profit from this trade, the downside is you are likely missing out on more upside potential had you not sold the covered call. The seller of the covered call doesn’t have to do anything, as the broker will take care of the assignment for you.
Are Options Automatically Assigned?
If you are an option seller, your option will either be exercised by the buyer or automatically assigned if it is ITM on the expiration date.
If you are an option buyer, your option will not be automatically assigned before expiration. However, most brokers will automatically assign ITM options on the expiration date.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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Options Assignment Prior to Expiration
An American-Style option seller (writer) may be assigned an exercise at any time until the option expires. This means that the option writer is subject to being assigned at any time after he or she has written the option until the option expires or until the option contract writer closes out his or her position by buying it back to close. Early exercise happens when the owner of a call or put invokes his or her rights before expiration. As the option seller, you have no control over assignment, and it is impossible to know exactly when this could happen. Generally, assignment risk becomes greater closer to expiration, however even with that being said, assignment can still happen at any time when trading American-Style Options.
When selling a put, the seller has the obligation to buy the underlying stock or asset at a given price (Strike Price) within a specified window of time (Expiration date). If the strike price of the option is below the current market price of the stock, the option holder does not gain value putting the stock to the seller because the market value is greater than the strike price. Conversely, If the strike price of the option is above the current market price of the stock, the option seller will be at assignment risk.
Selling a call gives the right to the call owner to buy or “call” stock away from the seller within a given time frame. If the market price of the stock is below the strike price of the option, the call holder has no advantage to call stock away at higher than market value. If the market value of the stock is greater than the strike price, the option holder can call away the stock at a lower than market value price. Short calls are at assignment risk when they are in the money or if there is a dividend coming up and the extrinsic value of the short call is less than the dividend.
What happens to these options?
If a short call is assigned, the short call holder will be assigned short shares of stock. For example, if the stock of ABC company is trading at $55 and a short call at the $50 strike is assigned, the short call would be converted to short shares of stock at $50. The account holder could then decide to close the short position by purchasing the stock back at the market price of $55. The net loss would be $500 for the 100 shares, less credit received from selling the call initially.
If a short put is assigned, the short put holder would now be long shares of stock at the put strike price. For example, with the stock of XYZ trading at $90, the short put seller is assigned shares of stock at the strike of $96. The put seller is responsible for buying shares of stock above the market price at their strike of $96. Assuming, the account holder closes the long stock position at $90, the net loss would be $600 for 100 shares, less credit received from selling the put originally.
Margin Deficit from the option assignment
If the assignment takes place prior to expiration and the stock position results in a margin deficit, then consistent with our margin policy accounts are subject to automated liquidation in order to bring the account into margin compliance. Liquidations are not confined to only shares that resulted from the option position.
Additionally, for accounts that are assigned on the short leg of an option spread, we will NOT act to exercise a long option held in the account. We cannot presume the intentions of the long option holder, and the exercise of the long option prior to expiration will forfeit the time value of the option, which could be realized via the sale of the option.
Post Expiration Exposure, Corporate Action and Ex-Dividend Events
We have proactive steps to mitigate risk, based upon certain expiration or corporate action related events. For more information about our expiration policy, please click here .
Account holders should refer to the Characteristics and Risks of Standardized Options disclosure document which is provided by us to every option eligible client at the point of application and which clearly spells out the risks of assignment. This document is also available online at the OCC's website.
Copyright © 2023 | Interactive Brokers LLC | All Rights Reserved
Interactive Brokers LLC Is a member NYSE - FINRA - SIPC and regulated by the US Securities and Exchange Commission and the Commodity Futures Trading Commission. Headquarters: Two Pickwick Plaza , Greenwich, CT 06830 , USA Website: www.interactivebrokers.com
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.
Options on futures are derivative instruments similar to the options you might buy on a single stock, but instead of the underlying asset being shares of a specific company, the underlying asset is a futures contract.
What is an Assignment in Options?
How does assignment work, what does “write an option” mean, how do you know if an option position will be assigned, what happens after an option is assigned, short put vs. short call, option assignment examples, option assignment summed up, supplemental content, what is an option assignment & how does it work.
Options assignment refers to the process in which the obligations of an options contract are fulfilled. This happens when the holder of an options contract decides to exercise their rights.
When an option holder decides to exercise, the Options Clearing Corporation (OCC) will randomly assign the exercise notice to one of the option writers.
A call option gives the holder the right to buy an underlying asset at a specified price (the strike price) within a certain period. If the holder decides to exercise a call option, the seller (writer) of the option is obligated to sell the underlying asset at the strike price. In this case, the option seller is said to be "assigned."
A put option gives the holder the right to sell an underlying asset at a specified price within a certain period. If the holder decides to exercise a put option, the seller of the option is obligated to buy the underlying asset at the strike price. Again, the option seller is "assigned" in this scenario.
Importantly, being assigned on an option can lead to significant financial obligations, particularly if the option writer does not already own the underlying asset for a call option (known as a naked call) or does not have the cash to buy the underlying asset for a put option. Therefore, option writers should be prepared for the possibility of assignment.
Options assignment works in tandem with the exercise of an options contract. It's the process of fulfilling the obligations of the options contract when the option holder decides to exercise their rights.
In general, the options assignment process includes four steps, as outlined below:
Option Exercise : The holder of the option (the investor who purchased the option) decides to exercise the option. This decision is typically made when it is beneficial for the option holder to do so. For example, if the market price of the underlying asset is favorable compared to the strike price in the option contract.
Notification : When the option is exercised, the Options Clearing Corporation (OCC) is notified. The OCC then selects a member brokerage firm, which in turn chooses one of its clients who has written (sold) an options contract of the same series (same underlying asset, strike price, and expiration date) to be assigned.
Assignment : The selected option writer (the investor who sold the option) is then assigned by the brokerage. The assignment means that the option writer now has the obligation to fulfill the terms of the options contract.
Fulfillment : If it was a call option that was exercised, the assigned writer must sell the underlying asset to the option holder at the agreed-upon strike price. If it was a put option that was exercised, the assigned writer must buy the underlying asset from the option holder at the strike price.
Writing an option refers to the act of selling an options contract.
This term is used because the seller is essentially creating (or "writing") a new contract that gives the buyer the right, but not the obligation, to buy or sell a security at a predetermined price within a specific period.
There are two types of options that investors/traders can write: a call option or a put option. Further details for each are outlined below:
Writing a Call Option : This process involves selling someone the right to buy a security from you at a specified price (the strike price) before the option expires. If the buyer decides to exercise their right, you, as the writer, must sell them the security at that strike price, regardless of the market price. If you don't own the underlying security, this is known as writing a naked call, which can involve substantial risk.
Writing a Put Option : This process involves selling someone the right to sell a security to you at a specified price before the option expires. If the buyer decides to exercise their right, you, as the writer, must buy the security from them at that strike price, regardless of the market price.
When an investor/trader writes an option, he/she receives the option’s premium from the buyer. This premium is theirs to keep, regardless of whether the option is exercised.
However, writing options can be a highly risky endeavor, so investors and traders should be aware of these risks (and accept) them, prior to engaging in options writing activity.
For call options, if the market price goes much higher than the strike price, the option writer (i.e. seller) is still obligated to sell at the lower strike price. For put options, if the market price goes significantly lower than the strike price, the option writer (i.e. seller) must buy the asset at the higher strike price, potentially resulting in a loss.
As such, writing options (i.e. selling options) is typically reserved for experienced investors/traders who are comfortable with the risks involved.
It’s impossible to know for certain if a given option will be assigned.
However, there are several situations in which an option assignment becomes more likely, as detailed below:
In-the-money (ITM) Options : An option is more likely to be exercised, and therefore assigned, if it's in the money . That means the market price of the underlying asset is above the strike price for a call option, or below the strike price for a put option. This is because exercising the option in such a scenario would be profitable for the option holder.
Near Expiration : Options are also more likely to be exercised as they approach their expiration date, particularly if they are in the money. This is because the time value of the option (a component of its price) diminishes as the option nears expiration, leaving only the intrinsic value (the difference between the market price of the underlying asset and the strike price).
Dividend Payments : For call options, if the underlying security is due to pay a dividend, and the amount of the dividend is larger than the time value remaining in the option's price, it might make sense for the holder to exercise the option early to capture the dividend. This could lead to early assignment for the writer of the option.
Remember, even if the above scenarios exist, it does not guarantee assignment, as the option holder might not choose to exercise the option. The decision to exercise is entirely up to the option holder.
Therefore, when writing (i.e. selling) options, investors and traders should be prepared for the possibility of assignment at any time until the option expires.
Remember, as the writer of the option, you receive and keep the premium regardless of whether the option is exercised or not. But this premium may not be sufficient to offset any loss from the assignment. That's why writing options involves risk and requires careful consideration.
1. Call Option Assignment:
Imagine a scenario in which you've written (sold) a call option for ABC stock. The call option has a strike price of $60 and the expiration date is in one month. For selling this option, you've received a premium of $5.
Now, let's say the stock price of ABC stock shoots up to $70 before the expiration date. The option holder can choose to exercise the option since it is now "in-the-money" (the current stock price is higher than the strike price). If the option holder decides to exercise their right, you, as the writer, are then assigned.
Being assigned means you have to sell ABC shares to the option holder for the strike price of $60, even though the current market price is $70. If you already own the ABC shares, then you simply deliver them. If you don't own them, you must buy the shares at the current market price ($70) and sell them at the strike price ($60), incurring a loss.
2. Put Option Assignment:
Suppose you've written a put option for XYZ stock. The put option has a strike price of $50 and expires in one month. You receive a premium of $5 for writing this option.
Now, if the stock price of XYZ stock drops to $40 before the option's expiration date, the option holder may choose to exercise the option since it's "in-the-money" (the current stock price is lower than the strike price). If the holder exercises the option, you, as the writer, are assigned.
Being assigned in this scenario means you have to buy XYZ shares from the option holder at the strike price of $50, even though the current market price is $40. This means you pay more for the stock than its current market value, incurring a loss.
What does an option assignment mean?
What happens when a call is assigned.
If it was a call option that was exercised, the assigned writer must sell the underlying asset to the option holder at the agreed-upon strike price.
What happens when a short option is assigned?
How often do options get assigned.
The frequency with which options get assigned can vary significantly, depending on a number of factors. These can include the type of option, its moneyness (whether it's in, at, or out of the money), time to expiration, volatility of the underlying asset, and dividends.
According to FINRA , only about 7% of options positions are typically exercised. But that does not imply that investors can expect to be assigned on only 7% of their short positions. Investors may have some, all, or none of their short options positions assigned.
How often do options get assigned early?
According to FINRA , only 7% of all options are exercised, which indicates that early assignment options constitute an even lower percentage of the total than 7%.
How late can options be assigned?
In most cases, options can be exercised (and thus assigned to the writer) at any time up to the expiration date for American style options. However, the exact timing can depend on the rules of the specific exchange where the option is traded.
Typically, the holder of an American style option has until the close of business on the expiration date to decide whether to exercise it. Once the decision is made and the exercise notice is submitted, the Options Clearing Corporation (OCC) randomly assigns the exercise notice to one of the member brokerage firms with clients who have written (sold) options in the same series. The brokerage firm then assigns one of its clients.
Do I keep the premium if I get assigned?
As the writer of the option, you receive and keep the premium regardless of whether the option is exercised or not. But this premium may not be sufficient to offset any loss from the assignment. That's why writing options involves risk and requires careful consideration.
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Avoiding Early Assignment on Naked Puts
This article on avoiding early assignment on naked puts is part of a series - see also Naked Put Assignment Overview (Part 1) and How to Repair an Early Naked Put Assignment (Part 3).
Early Naked Put Assignment Scenarios
Now there are basically two scenarios where early assignment might take place , although both scenarios share a common denominator. And that common denominator is when the "time value" portion of the put's premium nears zero.
If time value remains on the put, it makes more sense for the put owner to simply sell to close the put and then sell the shares because that will produce more cash in the end.
If, however, there is very little time value premium remaining (i.e. the put is comprised almost entirely of intrinsic value, or the amount by which it's in the money), then from the put owner's perspective, it's probably going to make more sense to just exercise the put, pay one commission, and just just be done with it. Especially if there are other opportunities for his or her capital.
Monitoring your in the money naked/short put position is always a good idea in case your trade slowly creeps in this direction. But there are a couple other "big event" type occurrences you'll definitely want to pay close attention to.
A scheduled earnings release is one such event, especially when the market is disappointed after the fact and there's a significant drop in the share price. In such a situation the "time value" on a put takes a double it.
The first hit is that much of the elevated levels of expected or implied volatility is expended once the uncertainty of the earnings has been resolved.
And second , in the case where the share price drops following the earnings release, the deeper the put goes in the money - the farther the share price trades from your strike price - the less time value is included in the put's premium.
Something similar occurs on the ex-dividend date , and the higher the dividend/dividend yield , the more pronounced the effect becomes.
Recall that the ex-dividend date is the date on which purchases of the shares no longer qualify you to receive that quarter's dividends.
So if I own the underlying shares on which I also own a protective put , and I want to unload my shares, I'd be crazy to exercise my put prior to the ex-dividend date because I'd screw myself out of receiving the dividend.
But on the ex-dividend date, all that changes. At that point, I'm free to exercise my put, unload my shares at the agreed upon strike price, and still be able to look forward to receiving my dividends on the upcoming payout date.
So the easiest way to avoid early naked put assignment is simply to roll or adjust your trade as soon as the risk of early assignment increases (as detailed above).
Something to think about - if you roll just prior to earnings or the ex-dividend date, the time value part of the premium will still be at an elevated level.
I prefer instead to roll immediately after the event in question occurs - that way when I roll, I'm buying time value at depressed levels and reselling or rewriting in the future when time value is once again elevated - maybe I even go out another 3 months to catch the next earnings and/or dividend cycle .
But be warned - the longer you wait after such an event to roll or adjust a position, the more time you allow hedgers out there to exercise their put.
So what happens if you actually do get assigned? Check out Part 3 of 3 part series - How to Repair an Early Naked Put Assignment .
Return from Avoiding Early Assignment on Naked Puts to Option Adjustment Strategies
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>> Constructing Multiple Lines of Defense Into Your Put Selling Trades (How to Safely Sell Options for High Yield Income in Any Market Environment)
Option Trading and Duration Series
Part 1 >> Best Durations When Buying or Selling Options (Updated Article)
Part 2 >> The Sweet Spot Expiration Date When Selling Options
Part 3 >> Pros and Cons of Selling Weekly Options
>> Comprehensive Guide to Selling Puts on Margin
Selling Puts and Earnings Series
>> Why Bear Markets Don't Matter When You Own a Great Business (Updated Article)
Part 1 >> Selling Puts Into Earnings
Part 2 >> How to Use Earnings to Manage and Repair a Short Put Trade
Part 3 >> Selling Puts and the Earnings Calendar (Weird but Important Tip)
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Part 1 >> Myth of Efficient Market Hypothesis
Part 2 >> Myth of Smart Money
Part 3 >> Psychology of Secular Bull and Bear Markets
Part 4 >> How to Know When a Stock Bubble is About to Pop
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