Have you ever been assigned in options trading? Many traders have gone through assignment at some point in their career. This article is meant to be a refresher on the “ins and outs” of option assignment. Before getting into specifics about assignment in options trading, it's worth re-visiting the basics about buying and selling options as it relates to assignment:
- A call option gives the buyer the right, but not the obligation, to buy a specific underlying at a specific price by a specific date. As the call buyer, you have the choice whether or not you want to exercise the option. If you exercise your right to purchase shares of the stock (100 shares for each option contract). The seller of the call option will automatically have 100 shares called away from his account.
- A put option gives the buyer the right, but not the obligation, to sell a specific underlying at a specific price by a specific date. This means that if the put option expires in the money, the put seller has the obligation to purchase the stock at the same strike price.
As the put buyer, if you exercise your right to sell stock, then the seller will automatically be sold 100 shares of stock per option contract. If the new stock is something the seller wants to keep, he certainly can if he has the available funds in his account. If he chooses to do so, he will now own 100 shares/contract at the strike price.
The specific date as defined above is the option's expiration date. On or prior to the expiration date, the buyer of the option has the right to exercise the option. The term “exercise” stands for the process by which the buyer of an option converts the option into a long stock position in the case of a call, or a short stock position in the case of a put. Buyers of options can exercise.
Now, let's talk about the term “assignment”
The term “assignment” refers to the process by which the seller of an option is notified of the buyer's intention to exercise that option. The exercise price (strike price) is the price at which the holder of the option has the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put), the underlying security. Sellers of options can be assigned.
The three most common questions related to trading options and being assigned stock are
- What situations would cause me to get assigned stock?
When you’re the option buyer, you have the power to assign. If you are the option seller, that is a different story…
When you sell an option (a call or a put), you will be assigned stock if your option is in the money at 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. With that said, assignment can still happen at any time. *One Important Note: there is additional assignment risk when a company has upcoming dividends (dividends are when a company distributes cash to shareholders). Essentially, if the extrinsic value on an ITM short call is LESS than the dividend amount, the ITM call owner will have good reason to exercise their option so that they can realize the dividend associated with owning the stock.
- What can I do to help prevent being assigned stock? There are two ways:
- You can close the trade before it expires and take any profit or loss on the trade
- You can roll the trade to extend the days to expiration, giving you more time to be right on your original entry premise.
- And…If I am assigned, what should I do?
Assignment can happen pretty easily if you are not monitoring you positions on a regular basis (and can happen even if you are). There are two things that can happen if you sold an option that has expired in the money…
- If you were assigned stock and had the money to cover the shares in your account, then you can choose to hold the long (or short) stock, or buy/sell the shares back for a profit or loss.
- If you were assigned shares and don't have the money to cover the shares you were assigned (the term for this is a margin call), you will need to buy/sell back the shares ASAP. If you do not, the broker will do it for you before the end of the trading day.
Doesn't the use of vertical spreads versus long options minimize the risk of assignment?
When you sell a put spread or call spread, the assignment risk comes from your short strike expiring in the money . If both strikes expire in the money, they will essentially cancel each other out and you will not be assigned.
If you sell a call spread and the short strike is in the money at expiration, you will be forced to sell 100 shares per option contract to the buyer. If you sell a put spread and just the short strike is in the money at expiration, you will be assigned 100 shares of stock per contract.
In summary, here are a few things to keep in mind regarding assignment:
- Assignment can happen at any time – it is more likely to occur at expiration; but remember it is controlled by the option buyer.
- If you do not have funds in your account to cover long or short stock, you should close the position immediately.
- Vertical spreads give more protection against being assigned, but they do not protect you unless BOTH legs are in the money.
- If you have a short call position, there is additional assignment risk if that call is in the money at the time of the dividend.
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I hope this article provides some “food for thought” on assignment in options trading. If you have an experience on being assigned that you would like to share feel free to comment below.