Summary of "Assignment Explained: What Every Options Trader and Investor Should Know"
This article, authored by Koen Hoorelbeke, is the first part of a four-part mini-series focused on the concept of options assignment, aimed at both novice and experienced traders. Understanding assignment is crucial for managing risk and capitalizing on opportunities in options trading.
What is Assignment?
Assignment occurs when the buyer of an option exercises their right, and the seller (or writer) of the option is required to fulfill the contract. For instance, if you sold a put option, you may be assigned and obligated to purchase shares. Conversely, if you sold a call option, you may need to deliver shares. This process is not punitive; it is simply the execution of the contract.
Types of Options
The article primarily discusses American-style options, which can be exercised at any time before expiration. In contrast, European-style options can only be exercised at expiration and are typically cash-settled. The focus is on individual stocks and ETFs, as options on futures have different clearing rules.
How Assignment Works
When an option holder exercises their right, the request is processed through the Options Clearing Corporation (OCC), which assigns the request to a clearing firm. The broker then allocates the assignment to individual accounts, often using random selection or FIFO (first-in, first-out) methods. Early assignment can occur under specific conditions, such as when an option is deep in the money, has little time value left, or is approaching a dividend date.
Implications for Investors
For investors, common scenarios include selling covered calls or cash-secured puts. If a stock price rises above the strike price of a short call before the ex-dividend date, early assignment may occur, resulting in the loss of the dividend. Similarly, if a stock price falls below the strike price of a short put, the investor may be assigned and required to buy shares. Often, these outcomes align with the investor's original strategy.
Complex Strategies and Assignment
For traders employing multi-leg strategies, such as spreads, assignment can complicate positions. For example, if a short call in a bull call spread is assigned, the trader may find themselves short shares but still holding a long call. While the risk remains defined, the composition of the position changes, necessitating a plan for managing the new exposure.
Timing and Management of Assignment
Assignment notices are typically received the morning after exercise. If an option is exercised late in the trading day, the notice will arrive before the market opens the next day. This timing emphasizes the importance of managing high-risk short options, especially as they approach expiration or dividends. The article also highlights "pin risk," where the underlying stock closes near the strike price, leaving uncertainty about assignment until the next trading day.
Conclusion
Traders are encouraged to track their short options and be aware of assignment risks. Understanding the factors that trigger assignment can help mitigate surprises. Ultimately, assignment should not be feared; it is a natural part of options trading that can be managed effectively with the right knowledge and strategies.