Exercise and Assignment of Stock Options
Subtitle
Exercise | Assignment
Exercise and Assignment of Stock Options
Learn how
Assignment occurs if and when an option buyer “exercises” the right to buy the shares that you have “sold” as an option seller. Less than 10% of options are ever assigned. So there is actually a relatively low chance that your options contract will ever be exercised. The risk will go up however, if your option contract is over the periods of an dividend distribution ( prior to the ex-dividend date ) or towards the end of a contract.
Recall that when you sell a put or call option, you are receiving a premium in exchange for the obligation to sell a buyer 100 shares of stock per contract IF an options buyer “chooses” to exercise their right to buy the contract shares.
Recall also that you have the ability to write ( sell ) the call or put option whether you actually own the shares or not. And as we will describe here, depending on whether you own the shares are not, the assignment is handled differently.
If you own the stock:
If you write ( sell ) a call or a put and you own the stock, you will be obligated to sell the stock to the option buyer. Your stocks will be “called away” from you at the strike price. Later sections will describe how to deal with assignment.
If you don’t own the stock:
If you write ( sell ) a call or a put and you don’t own the stock, you will need to purchase the stock. You, after all, cannot deliver what you don’t own. You will have to first purchase the stock before “selling” the stock to the option buyer. You will purchase the stock at the market price. Margin might be required if you don’t have sufficient funds to make the purchase. The morning after being “assigned” you will find yourself owning 100 shares of the underlying stock and your account will be deducted the dollar amount of the stock purchase. Later sections will describe how to deal with assignment.
If an option writer is short an option that expires in-the-money, they should expect assignment on that contract, though assignment is not guaranteed as some long in-the-money option holders may elect not to exercise in-the-money options. In fact, some option writers are assigned on short contracts when they expire exactly at-the-money or even out-of-the money. This occurrence is usually not predictable.
of a An options as
Yes, while in the money long options are automatically exercised only during expiration, as long as you are holding in the money short options, you are in “danger” of an assignment anytime before expiration, it doesn’t happen only during expiration.
Buyers of options have the right to exercise their option at or before the option’s expiration. When an option is exercised, the option holder will buy (for exercised calls) or sell (for exercised puts) 100 shares of stock per contract at the option’s strike price.
Conversely, when an option is exercised, a trader who is short the option will be assigned 100 long (for short puts) or short (for short calls) shares per contract.
The following sequences summarize exercise and assignment for calls and puts (assuming one option contract):
- Call Buyer Exercises Option ➜ Purchases 100 shares at the call’s strike price.
- Call Seller Assigned ➜ Sells/shorts 100 shares at the call’s strike price.
- Put Buyer Exercises Option ➜ Sells/shorts 100 shares at the put’s strike price.
- Put Seller Assigned ➜ Purchases 100 shares at the put’s strike price.
The most common scenario for being assigned on a short option is before a stock’s ex-dividend date. The short call is in the money and has less value than the dividend date.
Therefore, be careful if you are planning to sell a call in a calendar where there underlying stock has a dividend approaching.
If you sell ( write ) an option and then are assigned, you will be forced to buy 100 shares of the stock per contract at the strike price. That is, you will be forced to buy 100 shares of the the stock at the strike price.
So if I sold 1 contract on XYZ at 100 strike for 10 dollars and a buyer wanted to “exercise” the contract when XYZ was 80:
I would be obligated to buy 100 shares XYZ per contract at the strike price of 100 dollars when the XYZ was 80 dollars.
They buyer is exercising their right to
Usually, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option. The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option.
Assuming you own 100 shares of a stock trading at $30 and wrote 1 contract of $35 strike price call options for $1.00. Days before expiration, the stock rallies to $40 and the the short call options receives an options assignment. That option disappears along with your stocks. Your stocks get sold at $35 (even though the market price is $40) and you make $35 – $30 = $5 x 100 = $500 on your stocks and $1.00 x 100 = $100 on your short call options. So you lock in a total profit of $600 when that options assignment happens.
Call options allow you to buy the underlying stock at its strike price. As such, when you hold an in the money call option and it expires in the money, it gets automatically exercised, the option disappears with whatever value it carries (yes, the whole value disappears) and you buy the underlying stocks at the strike price of the call options.
Assuming you 100 shares of a stock trading at $30 and buys 1 contract of $30 strike price put options in order to protect those stocks for $1.00.
By expiration, the price of the stock falls to $20, bringing the put options in the money and gets automatically exercised.
The put options disappears and you lose $1.00 on the put options.
You sell your stocks at $30, losing nothing but commissions.
Assuming you short 100 shares of a stock trading at $30 and wrote 1 contract of $25 strike price put options for $1.00. Days before expiration, the stock drops to $20 and the the short put options receives an options assignment. That option disappears along with your short stocks. Your stocks get closed off at $25 (even though the market price is $20) and you make $30 – $25 = $5 x 100 = $500 on your stocks and $1.00 x 100 = $100 on your short put options. So you lock in a total profit of $600 when that options assignment happens.
WHAT HAPPENS WHEN SHORT PUT OPTIONS GET AUTOMATICALLY EXERCISED?
As a writer of a short put option, you are obligated to buy from the holder of the put option, the underlying stock at the strike price upon exercise or options assignment. Similarly, the whole value of the short put options disappear upon assignment. There are two situations to know here:
1. You do not own short stocks
If you are not already short the underlying stock, meaning you wrote a naked put write, then you will end up buying the stocks sold at the strike price of the put options (because you gave the holder of the put options the right to sell to you the options at the strike price). Now, if you do not have enough cash to buy the stock position, your broker would usually just close the whole position and post the resultant profit or loss to your account. Again, such options assignments WILL happen during expiration if those short put options are in the money and it MIGHT (random chance) also happen anytime before expiration if they are in the money.
WHAT HAPPENS WHEN SHORT PUTS OPTIONS GET AUTOMATICALLY EXERCISED
– NO UNDERLYING SHORT STOCKS
>Assuming you wrote 1 contract of $40 strike price put options on a stock trading at $30 for $10.00. Days before expiration, the put options receives an options assignment. That option disappears with its full value making you the full $1000 value in profit and you receive stocks bought at the price of $40. You would notice that you didn’t really profit from that $1000 as you would still need to close the stock position by selling the stock at $30, which is a loss of $40 – $30 = $10 x 100 = $1000.
1. You own the underlying short stock
If you are writing put options as part of a covered put and the short put options are subjected to options assignment before or during expiration, then what happens is that your stocks get closed out at the strike price of the put options and you no longer own neither the short stock nor the put option. You would also reap the full value of the short option as profit.
WHAT HAPPENS WHEN LONG CALL OPTIONS GET AUTOMATICALLY EXERCISED
Assuming you own 1 contract of $20 strike price call options on a stock trading at $30. During expiration, the call options are worth $10 and gets automatically exercised. That $10 x 100 = $1000 value completely disappears and you buy 100 shares of the underlying stock at $20 for $20 x 100 = $2000.
You are not losing out because now you have the rights to sell that stock at the market price of $30, so that $1000 lost is actually in that difference. You don’t lose anything more than commissions when this options exercise happens.
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WHAT HAPPENS WHEN LONG PUT OPTIONS GET AUTOMATICALLY EXERCISED?
Put options allow you to SELL the underlying stock at its strike price. As such, when you hold an in the money put option and it expires in the money, it gets automatically exercised, the option disappears with whatever value it carries (yes, the whole value disappears) and you SHORT the underlying stocks at the strike price of the put options.
WHAT HAPPENS WHEN LONG PUT OPTIONS GET AUTOMATICALLY EXERCISED
Assuming you own 1 contract of $40 strike price put options on a stock trading at $30. During expiration, the put options are worth $10 and gets automatically exercised. That $10 x 100 = $1000 value completely disappears and you short 100 shares of the underlying stock at $40 for total value of $40 x 100 = $4000.
You are not losing out because now you can buy back that stock at the market price of $30 for a total of just $30 x 100 = $3000, clocking in the $1000 difference. You don’t lose anything more than commissions when this options assignment happens.
If you are buying put options as part of a “Protective Put” strategy, this means that you are buying put options as protection for the stocks that you own, when those put options are exercised, you will sell (and lose) your stocks at the strike price of the put options. The put option you bought will also disappear with whatever value it carries..
Approximately 7% of options contracts will get assigned. That means that 93% of all options contracts will not be assigned.
Options assignment is therefore not something that should be significantly be afraid of.
This is especially true when you consider that there are strategies to deal with assignment with only minor headaches and losses.
Only 21 percent of options contracts held through expiration are exercised. The majority will be left to expire worthless.
How to Handle an Options Assignment
When do buyers exercise their options
In order to remove the fear of options assignment and understand how to avoid setting up your trades to decrease the potential for assignment, you will want to understand the conditions where buyers might be incentivized to buy exercise their right to buy your options.
The simple answer is that options will only be exercised if the stock price is above the strike price ( for call options ) and usually when expiration has arrived.
It is extremely rare, and almost unheard of, for a buyer to exercise a contract that is not in the money. The buyer will only exercise the contract if the stock price is above the strike price. If the stock price is below the strike price, there is no incentive to want to buy a stock at a higher price.
If is also uncommon for a contract to be exercised before expiration day. This is because there is still extrinsic time value contained in the contract. This extrinsic time value decreases with time and is essentially zero on the day of expiration.
If at the end of expiration, the stock price is even 1 cent above the strike price, the stock will be automatically be called away. So if you are selling covered, calls as a strategy, you will regularly be expected to be assigned if the stock price exceed the strike price. You will be expected to sell your stock to the buyer.
Far ITM Put Options are potentially exercised –
- Unless
How to Handle an Options Assignment
The risk of assignment at the time of expiration
The ideal outcome for a trader who writes ( sells ) a call option if for the stock price to remain below the strike price at the time of expiration. Less than 10% of these options will be exercised.
- If the option does not get exercised, you get to pocket the premium and keep the stock if you own it.
- You also get to sell another call against the stock
- This is the perfect outcome.
All short stock options which are 1 cent or more in the money during expiration will be automatically assigned in what is known as an “Automatic Assignment” by the OCC. Even though different brokers might have different thresholds, it rarely differs much from the OCC threshold.
OPTIONS ASSIGNMENT PRIOR TO EXPIRATION
Options assignment prior to expiration, or early assignment, is completely random and might happen as long as you hold short in the money options.
Alot of options beginners like to ask “what happens if the holder of the options that I sold (wrote) exercise the options?” The truth is, there is no way to know when and if the holder of a short option is going to exercise an option and its not important to know because in reality, this process is completely random and handled by the exchange. Whenever there is an exercise, holders of short options positions capable of fulfilling that exercise is actually randomly chosen for fulfillment by the exchange. This process is known as the “Automatic Assignment”.
Even though there are some generalisations over the kind of options that typically gets assigned, there is no sure way you can tell if you would be the next candidate for an assignment and that creates uncertainty when shorting in the money options in options trading. This is also why options margin is required when writing options. That is to ensure that you have sufficient funds to meet assignment requirements.
You get an “assignment notice” when your short options are assigned. Options assignments occur when buyers of options exercise the options they bought. The Options Clearing Corporation (OCC) then uses a random procedure to assign exercise notices to Clearing members under them. These firms then use an exchange approved method (usually a random process or the “first-in, first-out” method) to allocate those notices to accounts which are short the options.
Please note at this point that option assignment prior to expiration happens only to American style options which could be exercised before expiration. European style options which could not be exercised before expiration would not be subjected to early options assignment.
OPTIONS ASSIGNMENT THRESHOLD DURING EXPIRATION
OPTIONS ASSIGNMENT QUESTIONS:
:: What To Do When One Leg of Bull Call Spread Is Assigned?
:: What To Do When Short Leg of Put Spread is Assigned?
:: Automatic Assignment Once Strike Price is Hit?
Far ITM Put Options are potentially exercised –
- Unless
How to Handle an Options Assignment
Avoiding assignment
A trader must decide before writing ( selling ) a covered call whether or not they would mind having their stock “called away”. Many traders will have a few long stocks that they want to keep, but will carry long stocks in a separate bucket that they might use in their options selling strategies that they don’t mind having called away.
If you absolutely don’t want your long stocks to be called away, you should not be writing covered calls!
However, if you choose to write covered calls against a stock that you want to keep, you can always avoid assignment by buying back the option. You might have a loss on the position, but you will by buying back the option prior to expiration, gain back control of your stocks.
Far ITM Put Options are potentially exercised –
- Unless
How to Handle an Options Assignment
Early assignment
Assignment at the end of an expiration period can often be anticipated; and in fact, many covered call traders count on it as part of their trading strategy.
It is really the fear of the “unexpected” early assignment that can be dreaded. Early assignment is extremely rare. Even if the option is deep in the money, the chances of early assignment is very small. This is because that the further you are from the time of expiration, the more extrinsic time value remains in the options contract; that is, the option is not worth as much as you think.
The one major exceptions is if a buyer is interested in capturing any dividends associated with your stocks. Simplistically, whoever owns the stock owns the dividend payout. If a buyer recognizes that your stock has dividends that exceeds the extrinsic time value on your stock, that buyer might exercise their right to buy your stock and capture its dividend early in the contract cycle.
Far ITM Put Options are potentially exercised –
- Unless
How to Handle an Options Assignment
Book Excerpts
When you sell covered calls (or uncovered calls, which we’ll discuss later), before the stock can be called away (i.e., assigned), the call buyer must exercise his rights. The buyer does not have to exercise, but has the right to exercise. It is a choice. If any buyer does exercise the call option, and if that exercise notice is assigned to your account, you are required to deliver shares of the stock on which the calls were sold. Don’t worry—the OCC and your broker do it all automatically so you don’t actually have to do anything. From the covered call seller’s perspective, which is your perspective, the stock you own is taken from your account and sold at the strike price. You also get paid for selling the stock at the strike price. To review, at what price does the exerciser get to buy your shares? If you said at the strike price, then you are correct. If the buyer decides to exercise the option, the stock transaction is always at the strike price. This is according to the rules of the option contract. In summary, you could wake up on the Monday after the expiration date and discover that the stock on which you sold calls is no longer in your account because it was called away at the strike price. This is because the buyer decided to exercise his or her right to buy the stock. You could always buy back the stock immediately and sell calls on it for the next month. Some people do this every month. It’s important to remember that you are obligated to deliver the shares of stock to the call buyer. You do not have a choice. When you sell any call, you become obligated to sell stock at the strike price (but only when you are assigned an exercise notice). Let’s see what happens behind the scenes. When the buyer decides to exercise the option at the strike price, his brokerage firm notifies the Options Clearing Corporation (OCC). After the OCC takes over, it randomly selects a brokerage firm with a matching short position in that option. As a result, his stock was sold at the strike price and called away. The transaction took place overnight. It will look like any other sell transaction except it may have the word assignment next to it. In summary, exercise and assignment are a two-part process. First, the option is exercised. Next, the option seller is assigned (i.e., the seller of the call option is assigned an exercise notice, and the stock is sold). You can’t have one without the other. It’s really that simple, and yet it can sometimes
Sincere, Michael. Understanding Options 2E (pp. 83-84). McGraw-Hill Education. Kindle Edition.
Sincere, Michael. Understanding Options 2E (p. 84). McGraw-Hill Education. Kindle Edition.
Far ITM Put Options are potentially exercised –
- Unless the owner of an option ( not the short seller ) can’t sell the option for more than its its intrinsic value, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option
How to Handle an Options Assignment
What is the Net Profit or Loss after an option is exercised
When an investor exercises a call option
- the net price paid for the underlying stock on a per share basis is the sum of the call’s strike price plus the premium paid for the call.
- net price paid = strike price + premium paid
When an investor who has written a call contract is assigned an exercise notice on that call
- The net price received on per share basis is the sum of the call’s strike price plus the premium received from the call’s initial sale.
- net price received = strike price + premium received
When an investor exercises a put option
- The net price received for the underlying stock on per share basis is the sum of the put’s strike price less the premium paid for the put.
- net price received = strike price – premium received
When an investor who has written a put contract is assigned an exercise notice on that put
- The net price paid for the underlying stock on per share basis is the sum of the put’s strike price less the premium received from the put’s initial sale
- net price paid = strike price – premium received
Far ITM Put Options are potentially exercised –
- Unless the owner of an option ( not the short seller ) can’t sell the option for more than its its intrinsic value, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option
How to Handle an Options Assignment
What can you do if you your put option that is assigned is part of a credit spread?
If you are a. writer of a short put option and were assigned, you will be obligated to buy the stock ( the underlying ) at the strike price of the contract. If stock xyz moved OTM down to 80 and the strike price is 100, you will have to buy the stock at 100.
If you are a writer of a short put option and you do not want to keep the long shares ( you do not want to own the stocks that were assigned to you ) you will want to:
- When a risk defined trade moves in the wrong direction it can be adjusted to reduce risk, but then if the stock doesn’t move back consider closing to free up the capital to open a new that has the probabilities of profiting.
- If the trade is ITM and left to expire, or gets assigned early due to dividend risk for instance, then look at the other legs as individual positions and manage accordingly.
- For instance the remaining long leg can be closed to help pay for the short leg assignment, or in some cases it can be exercised to close the stock position.
- The unchallenged spread can be closed for a profit, or left to expire for full profit if well OTM.
- If the stock position is kept then covered calls or covered puts can be sold that can help bring the position back to break-even, or possibly a profit over time
Far ITM Put Options are potentially exercised –
- Unless the owner of an option ( not the short seller ) can’t sell the option for more than its its intrinsic value, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option
How to Handle an Options Assignment
What can you do if you are assigned a Put Option?
If you are a. writer of a short put option and were assigned, you will be obligated to buy the stock ( the underlying ) at the strike price of the contract. If stock xyz moved OTM down to 80 and the strike price is 100, you will have to buy the stock at 100.
If you are a writer of a short put option and you do not want to keep the long shares ( you do not want to own the stocks that were assigned to you ) you will want to:
- Sell the stock back immediately.
- You will obviously be selling the stock back for a loss. In the example above, you will have been obligated to buy the stock at 100 when the price of. the stock was 80.
- Selling back the stock immediately, however, will decrease the margin exposure to owning the long shares.
- Now, write another put contract at the original strike price. This will neutralize the effect of being assigned the shares. The effect of selling the contract for additional premium will net you a significantly smaller loss after assignment.
Far ITM Put Options are potentially exercised –
- Unless the owner of an option ( not the short seller ) can’t sell the option for more than its its intrinsic value, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option
How to Handle an Options Assignment
Early Options Assignments
It is extremely important to realize that assignment of exercise notices can occur early, days or weeks in advance of expiration day.
Investors should expect this as expiration nears with a call considerably in-the-money and a sizeable dividend payment approaching. Call writers should be aware of dividend dates and the possibility of early assignment.
When puts become deep in-the-money, most professional option traders exercise before expiration.
Therefore, investors with short positions in deep in-the-money puts should be prepared for the possibility of early assignment on these contracts.
Far ITM Put Options are potentially exercised –
- Unless the owner of an option ( not the short seller ) can’t sell the option for more than its its intrinsic value, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option
How to Handle an Options Assignment
Learning By Example
A short option can possibly assigned if it is in the money anytime before expiration.
Example Setup:
- You sold a put option at a 100 strike price
- The stock moved against you ( down ) and is now 90
The stock price is now 10 dollars in the money ( in the money means for put options means that the stock price is much lower than the strike price) )
The further a stock moves against you ITM, the more premium is lost to the option. But there is usually more premium value remaining as compared to the intrinsic value remaining.
- If there is little to no premium left to the option, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option.
If the owner exercises his option, then we are “assigned” on the contract. If you are assigned, you will find:
- 100 shares of the stock will show up in your portfolio
- You are forced to pay the strike price ( 100 dollars ) for the stock even though the stock moved to 90 dollars.
What will you do next?
- You can keep the stock for 100 dollars a share or
- You can sell the shares that you purchased for 100 dollars a share for the new price which is around 90 dollars.
- You can sell a new put above the new stock price.
Far ITM Put Options are potentially exercised –
- Unless the owner of an option ( not the short seller ) can’t sell the option for more than its its intrinsic value, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.
- The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option
Buying a Call
All In The Money Options are Exercised At Expiration
Most options traders will close their ITM in the money options prior to expiration. They can be closed all the way up to the close of the market on the day of expiration. This is done to avoid an automatic exercise or assignment.
- Exercise refers to when you are holding long options
- Assignment refers to when you are holding short options
All in the money options positions, whether long (options that you buy to open) or short (options that you sell to open), gets exercised automatically upon expiration.
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Buying a Call
What Happens When a Short Call Option is Automatically Exercised When You don't Own the Stock
WHAT HAPPENS WHEN SHORT CALL OPTIONS GET AUTOMATICALLY EXERCISED?
As a writer of a short call option, you are obligated to sell to the holder of the call option, the underlying stock at the strike price upon exercise. Similarly, the whole value of the short call options disappear upon expiration. There are two situations to know here:
1. You do not own the underlying stock
If you do not own the underlying stock, meaning you wrote a naked call write, then you will end up with short stocks sold at the strike price of the call options. Now, if you do not have enough margin to take on the short stock position, your broker would usually just close the whole position and post the resultant profit or loss to your account. Again, such assignments WILL happen during expiration if those short call options are in the money and it MIGHT (random chance) happen anytime before expiration if they are in the money.
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Buying a Call
What Happens When a Short Call Option is Automatically Exercised When You don't Own the Stock
Assuming you wrote 1 contract of $20 strike price call options on a stock trading at $30 for $10.00. Days before expiration, the call options receives an options assignment. That option disappears, making you the full $10.00 x 100 = $1000 in profit and you receive 100 short shares at the price of $20. You would notice that you didn’t really “make” that $1000 as you would still need to close the stock position by buying the stock at $30, which is a loss of $30 – $20 = $10 x 100 = $1000.
1. You own the underlying stock
If you are writing call options as part of a covered call and the short call options are subjected to options assignment before or during expiration, then what happens is that your stocks get sold at the strike price of the call options and you no longer own the stocks. You would also reap the full value of the short option as profit. This also means that you will benefit from any stock price above the strike price of the call options. This is part of the drawbacks of a Covered Call strategy.
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Buying a Call
Short Calls
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.
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Buying a Call
What Happens To These Options?
If an ITM call is assigned,
The call seller will be short shares of stock.
If the account holder does not have the funds to cover a short stock position, the brokerage will liquidate the stock at the market price.
For instance, if the stock is trading at $95 and a short call at the $90 strike is assigned, the short call seller would then own the stock at $90 and have to purchase stock at $95 to close the trade.
The net loss would be $5.00 per contract, 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 trading at $50, the short put seller is assigned shares of stock at the strike of $53.
- The put seller is responsible for buying shares of stock above the market price at their strike of $53.
- If the put seller can not afford to hold the shares of stock, the broker will liquidate the stock by selling it at the current market price of $50.
- The net loss would be $3.00, less credit received from selling the put originally.
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The Greeks
Automatic Exercise at Expiration
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- Another important thing to know about exercise and assignment is that standard in-the-money equity options are automatically exercised at expiration. So, traders may end up with stock positions by letting their options expire in-the-money.
- An in-the-money option is defined as any option with at least $0.01 of intrinsic value at expiration. For example, a standard equity call option with a strike price of 100 would be automatically exercised into 100 shares of stock if the stock price is at $100.01 or higher at expiration.
Buying a Call
What if you don't have enough capital?
Blurb
- Another important thing to know about exercise and assignment is that standard in-the-money equity options are automatically exercised at expiration. So, traders may end up with stock positions by letting their options expire in-the-money.
- An in-the-money option is defined as any option with at least $0.01 of intrinsic value at expiration. For example, a standard equity call option with a strike price of 100 would be automatically exercised into 100 shares of stock if the stock price is at $100.01 or higher at expiration.
Buying a Call
Why Options are Rarely Exercised
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- At this point, you understand the basics of exercise and assignment. Now, let’s dive a little deeper and discuss what an option buyer forfeits when they exercise their option.
- When an option is exercised, the option is converted into long or short shares of stock. However, it’s important to note that the option buyer will lose the extrinsic value of the option when they exercise the option. Because of this, options with lots of extrinsic value remaining are unlikely to be exercised. Conversely, options consisting of all intrinsic value and very little extrinsic value are more likely to be exercised.
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- Exercising options with lots of extrinsic value is not favorable. Why? Consider the 95 call trading for $7. Exercising the call would result in an effective purchase price of $102 because shares are bought at $95, but $7 was paid for the right to buy shares at $95. With an effective purchase price of $102 and the stock trading for $100, exercising the option results in a loss of $2 per share, or $200 on 100 shares.
- Even if the 95 call was previously purchased for less than $7, exercising an option with $2 of extrinsic value will always result in a P/L that’s $200 lower (per contract) than the current P/L. For example, if the trader initially purchased the 95 call for $2, their P/L with the option at $7 would be $500 per contract. However, if the trader decided to exercise the 95 call with $2 of extrinsic value, their P/L would drop to +$300 because they just gave up $200 by exercising.
- Because of the fact that traders give up money by exercising an option with extrinsic value, most options are not exercised. In fact, according to the Options Clearing Corporation, only 7% of options were exercised in 2017. Of course, this may not factor in all brokerage firms and customer accounts, but it still demonstrates a low exercise rate from a large sample size of trading accounts.
- So, in almost all cases, it’s more beneficial to sell the long option and buy or sell shares instead of exercising. We like to call this approach a “synthetic exercise.”
- Congrats! You’ve learned the basics of exercise and assignment. If you’d like to know how the exercise and assignment process actually works, continue to the next section!
Buying a Call
Who Gets Assigned When an Option is Exercised?
Blurb
- With thousands of traders long and short options in the market, who actually gets assigned when one of the traders exercises their option?
- In this section, we’ll run through the exercise and assignment process for options so you know how the assignment decision occurs
- If a trader is short a single option, how do they get assigned if one of a thousand other traders exercises that option
- The short answer is that the process is random. For example, if there are 5,000 traders who are long a call option and 5,000 traders who are short that call option, an account with the short option will be randomly assigned the exercise notice. The random process ensures that the option assignment system is fair
- The following visual describes the general process of exercise and assignment:
Buying a Call
Assessing Early Option Assignment Risk?
Blurb
- The final piece of understanding exercise and assignment is gauging the risk of early assignment on a short option.
- As mentioned early, only 7% of options were exercised in 2017 (according to the OCC). So, being assigned on short options is rare, but it does happen. While a specific probability of getting assigned early can’t be determined, there are scenarios in which assignment is more or less likely.
- In regards to the dividend scenario, early assignment on in-the-money short calls with less extrinsic value than the dividend is more likely because the dividend payment covers the loss from the extrinsic value when exercising the option
- All in all, the risk of being assigned early on a short option is typically very low for the reasons discussed in this guide. However, it’s likely that you will be assigned on a short option at some point while trading options (unless you don’t sell options!), but at least now you’ll be prepared!
Option Basics
Tips and Tricks
Generalizations :
- The more in the money the short options are, the more likely they are to be assigned.
- The nearer to expiration, the higher the chances of assignment.
- The nearer to ex-dividend date, the higher the chances of assignment for short in the money call options. Read about effects of dividends on stock options.
- About 12% of all options get exercised which translates to about 12% of all short options get assigned. Hence options assignments are not common.
- Short In the money put options have a higher chance of being assigned than short in the money call options as generally, more put options are exercised than call options
- If you are selling covered calls, assignment is a good outcome
- If you are assigned, the stock will be called away and sold at the strike price
- After the stock is called away, you can immediately buy it back by purchaseing shares in the stock market.
Why learn options
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