Have you ever been assigned in options trading? Many traders have gone through assignment at some point in their trading life, and it can be an uncomfortable feeling. Today's blog will be a refresher on the “ins and outs” of option assignment. Before I get into the 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 control 100 shares of stock and have the choice whether or not you want to exercise the option. If you exercise, your right is to purchase shares of the stock (100 shares for each option contract). When you buy a call option, you cannot be assigned stock unless you choose to exercise your option. Remember, it is your right, but not your obligation, to exercise that call option.
The seller of the call option will automatically have 100 shares called away from his account if the call buyer exercises his/her option.
- 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 of stock at the strike price per share.
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.
Here is an example of two traders engaging in buying and selling an option:
You:
- You purchased an AAPL (Apple) put option from Joe, at a strike price of $165, for the January 2019 expiration cycle.
- AAPL closed at 156.82 on January 18, which was the option's expiration date. Because AAPL closed below the strike price of $165, the option is expiring in-the-money and you decide to exercise the option.
- You sell 100 shares of AAPL to Joe for $165 per share (the strike price).
Joe:
- Joe sold an AAPL put option to you at a strike price of $165.
- The option expired in-the-money and the buyer (you) chose to exercise his option.
- Joe must purchase 100 shares of AAPL stock from you at $165 per share (even if there is not adequate capital in his account).
What happens next?
If Joe does not have sufficient funds in his account to purchase the stock, he will still own it, but for a short time. Joe will be required to close the position immediately (usually because Joe receives a margin call from his broker). Joe will also be charged an assignment fee, which varies depending on his broker, as well as commissions.
The 3 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. Having said that, however, assignment can still happen at any time.
An important note to remember is there is additional assignment risk when the underlying's company has upcoming dividends (dividends are when a company distributes cash to their 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. If you would like to read more about the intrinsic and extrinsic value of options, I published an article on August 17, 2018 titled “What are Intrinsic & Extrinsic Option Values”? That article can be found here: https://aeromir.com/00182/what-are-intrinsic-and-extrinsic-option-values
s 2. 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 another expiration cycle to extend the days to expiration. This will give you more time to be right on your original entry premise.
3. And…If I am assigned, what should I do?
Assignment can happen pretty easily if you are not monitoring your positions on a regular basis (and can also 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. Some traders assigned stock, and have the sufficient funds, may choose to retain the stock and write covered calls against it. This may be a strategy if you feel the stock will rebound over time; writing covered calls in the meantime can be a way to recover some of the realized loss as a result of being assigned.
- 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 will be required to 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.
Whether you are new to trading or a veteran looking to share your trade experiences with others, Aeromir is the place. We offer mentoring, educational trade alert services, and trading groups that meet on a regular basis.
I hope this article reduces any uncertainties you may have on assignment in options trading. If you have an experience on being assigned that you would like to share with others, feel free to comment below.
