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What is Option Assignment and Is it always bad?

Published on December 1, 2011

What is Option Assignment and Is it always bad?

December 1, 2011

Option Assignment is one word that a lot of option traders are scared of. For a primer of what is an option assignment, let me share the basic concept first. This is a detailed explanation from The Options Industry Council. You may also learn more from Pete here.

The option holder has the right to exercise his or her options position prior to expiration regardless of whether the options are in- or out-of-the-money. You can be assigned if an investor or market professional holding calls of the same series as your short position submits an exercise notice to his or her brokerage firms, which in turn, submitted an exercise notice to OCC (or if the brokerage firm is not an OCC Clearing Member, then it would submit the notice to a firm that is an OCC Clearing Member, and that Member would then submit the notice to OCC). OCC randomly assigns exercise notices to Clearing Members in whose accounts have short positions of the same series. The Clearing Member then assigns the exercise to one of its short positions using a fair assignment method, though not necessarily random. You should ask your brokerage firm how it assigns exercise notices to its customers.

My version-

If You sold an options at XYZ price, you are now obliged to sell shares (if you sold calls) or buy shares (if you sold puts) at that XYZ strike price when you are assigned.

That’s it. There is a whole range of FAQ that you may visit to understand Options Assignment and how it works.

 

Many consider options assignment to be risky. Is it always the case? Should you be worried?

If you have a friendly broker, options assignment is not something to be worried so much. However, this assumes you know how to liquidate position, are familiar with different trading strategies and can manage your risk well. Let’s take a few scenarios-

  1. Assume you were long AAPL 100 shares ($384.8 as of this writing) and you like to trade covered call option trading strategy so you sold a Jan 400 Call at $11.90. Thus you collected $1190 for each 100 shares. Now assume, by jan expiration AAPL is at 400.25 and you are assigned. Your shares will be sold @$400. Thus you will pocket a net gain of = $2630 [=$1190 + $1540 (= $400 (strike price-$384.6 price when you sold call)]. You made 6.8% in 50days (assuming no portfolio margin else yield will be even higher) and you are left with cash only. No options obligations, no shares!
  2. Assume you are working on other strategy called Cash Secured Put Option Trading Stratgy. In such a strategy, you sold Puts say at $360 strike and you kept $36,000 as deposit with your broker to let you sell 1 put. You will receive roughly $1000 credit. If AAPL is below $360 on Jan expiration, you will be sold shares at $360. You will get to keep $1000 credit and you will also have 100 AAPL shares. Now no Cash, no further obligations!

So where is the Risk? it all sounds too good to believe. There are risks in this strategies that I shall briefly cover later. If you are interested to know more, pls leave a comment and I shall cover more. But in both the cases as listed above, there is no assignment risk. Isn’t this the option trader wanted when the position was initiated? to sell shares at $400 or to Buy it at $360 vs current market price of $384.8. I am leaving assignment fee/other costs out of the scope of this post.

Where option assignment gets complicated- is when you have an option spread and especially when you have an unfriendly broker who might liquidate your positions at their will, probably at the worst time. If you have a good broker who gives you time to adjust/close positions, then in that case even option spread is not so complicated or risky. Here is a real-money example-

Yesterday, for OPNewsletter, we had a Bear Call Spread on Nike (NKE). Essentially-

  • Sold to Open NKE Dec 87.5 Call
  • Buy to Open NKE 92.5 Call

Yesterday’s closing credit was roughly $430 [risk is $70 (=$500-$430)] and NKE closed at $95.82

This morning, before markets opened, we were assigned on our Short Dec 87.5 call, thus crediting our account by $8750 (=$87.5 X100);

Thus post assignment: Cash Inflow= $8750 +$430 = $9,180; and Position is +1 NKE Dec 92.5 calls and -100 NKE shares.

Now we are assigned, should we panic? May be yes, if we don’t know what to do about it? and if we don’t know what is an option assignment and how to handle it.

  1. First scenario – NKE flies: It rally above $100 or whatever number you can think of. No matter what happens, the maximum risk is already defined; the position is covered by the long $92.5 calls. You can’t lose beyond that $70 plus assignment fee/brokerage costs, etc.
  2. Second Scenario-   NKE drops: This will actually make money. Let’s say it dropped to $95 (as it did today). You con buy the shares at $95, thus cash outflow =$9,500 and then sell the NKE $92.5 call at $400

Thus total Cash Outflow = $9,500-$400=$9100 Overall gains: Cash Inflow- Cash Out Flow = $9180-$9100= +$80

This was a real trade (prices in the above examples are approximate).

The example I shared above can be used to examine other kinds of spreads as well.

Before you conclude that option assignment is always a good thing, pls note that there are risks that one is exposed to.

  • For instance, if someone is trying to trade via predicting the markets e.g. buy NKE shares at the lowest point and sell 92.5 calls at the highest points, that might backfire if market continues only in direction and if that happens to be against the trader’s remaining opened position.
  • Other risk, as I mentioned before, is that your broker fulfills your obligation at his will and you are left with no choice. For example, he buys the shares at the highest and doesn’t sell the 92.5 calls. You may have to sell it at low price, thus resulting in losses.
  • There are costs/broker’s fee associated with options assignment.

Bottomline- I personally don’t think one needs to be scared of the options assignment. Get to know your broker, understand how do they work in such circumstances. Know your position and familiarize yourself with your trading platform and order types to know how/what can you do during such situations. You will be either short or long shares , thus incremental long or short delta.You can close the trade in a single order as well (to avoid directional risk) e.g. +100 shares and -1 NKE Dec 92.5 call

Overall, I personally think options assignment can be a good thing. If someone assigns me during the mid of the month, I get to keep all the theta in advance. Other times when I didn’t have theta, I used some simple intraday ranges to close the positions.

Enjoy and learn more about options assignment. Then comeback and review this post once again.

Profitable Learning, OP

2 Comments

  • Kirk says:

    I would just add that you always have to be aware of the options that you have on underlying and the different times at which they expire/assign. For example, the VIX actually stops trading on Wednesday and since it’s a European style you cannot exercise it until the last day (til around 2pm for most brokers I think).

  • OptionPundit says:

    That’s true Kirk. It’s better to know what kind of options are you trading in addition to knowing your broker’s guidelines about assignment.

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