Options Assignment

What is early options assignment? What happens when options get assigned?

Options Assignment - Introduction

Yes, the horrors of getting your options exercised (assigned) automatically!

This is what alot of options beginners fear but what is its effects, how does it happen and is it really that scary?

An options assignment happens when in the money options are assigned for fulfillment involuntarily. Involuntarily means that the holder of an in the money long options, despite not having initiated an options exercise, the exercise was made automatically during expiration or that the holder of an in the money short options position being made to fulfill the terms of the options that are written anytime during or BEFORE expiration. 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.
This free options tutorial shall go through what options assignment is, how possible is it before expiration and what happens when various options positions are assigned or exercised.

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 Automatic Exercise and Assignment During Expiration

All in the money options not exercised before expiration will be automatically exercised during expiration itself. 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. There are no exceptions. This is why most options traders close their in the money options prior to expiration, even minutes before market close on expiration Fridays, in order to avoid an automatic exercise or assignment. When you are holding long options, its known as an "Automatic Exercise" while if you are holding short options, its known as an "Automatic Assignment".

Can I Avoid Getting Automatically Exercised or Assigned During Expiration?

No. There are no exceptions unless you are holding out of the money options, in which case they simply Expire Worthless. If you are holding in the money options through expiration, they will be automatically exercised and assigned without exceptions.

What Happens When Long Call Options Get Automatically Exercised?

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.

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.

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.

What Happens When Short Call Options Get Automatically Exercised - No stocks 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.

What Happens When Short Call Options Get Automatically Exercised - With stocks 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.

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..

What Happens When Long Put Options Get Automatically Exercised - Protective Put 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.

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 Short Put Options Get Automatically Exercised - With short stocks 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.

Generalisations about Short Options Assignments Before Expiration

1. The more in the money the short options are, the more likely they are to be assigned.

2. The nearer to expiration, the higher the chances of assignment.

3. 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.

4. About 12% of all options get exercised which translates to about 12% of all short options get assigned. Hence options assignments are not common.

5. 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.

Options Assignment Threshold During Expiration

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 before expiration in options trading do not happen only when you write straight naked options. Options assignment in options trading can also happen to options which are written as part of an options trading strategy! This is why all options traders using complex options strategies need to take all possible options assignment scenarios into consideration when executing their options trading strategies in order to prevent an unexpected margin call.

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?