Options Assignment: Understanding the Risks and Opportunities

Imagine this: You've been selling covered calls on a stock you own, enjoying the extra income from the premiums.

One morning you wake up to find that your shares have been unexpectedly called away. Confused and a bit annoyed, you wonder what happened.

This scenario is a textbook example of options assignment - a process that can catch even experienced traders off guard.

As an options trader, understanding how assignment works is crucial for managing risk and seizing opportunities in the market.

Options assignment occurs when the buyer of an option decides to exercise their right to buy or sell the underlying stock at the agreed-upon strike price.

For option sellers, this means being obligated to fulfill the contract, whether by selling shares (in the case of a call option) or buying shares (for a put option).

While assignment is a normal part of options trading, it can sometimes lead to unexpected consequences, especially when it happens before expiration.

Early assignment can impact your portfolio in ways you might not have anticipated, potentially leading to losses or missed opportunities.

But here's the good news: By understanding the mechanics of options assignment and the factors that influence it, you can take steps to manage your risk and even profit from it.

In this article, we'll dive deep into the world of options assignment, exploring:

• What options assignment is and how it works
• The differences between call and put options assignment
• When and why assignment occurs, including factors like expiration dates and dividends
• The risks presented by assignment, both for option buyers and sellers
• Strategies for managing and mitigating assignment risk
• Real-world examples and case studies using Barchart's powerful options tools

Whether you're a seasoned options trader or just starting out, this guide will equip you with the knowledge and tools you need to confidently navigate the complexities of options assignment using Barchart's suite of options analysis features.

What is Options Assignment?

Before modern electronic exchanges and the Chicago Board of Options Exchange, options were only private agreements between two parties, often facilitated by brokers.

Eventually, digitization and standardization made it possible to quickly buy and sell these contracts between market participants.

Yet, the core principles of an option contract are the same today as they were 50 or even 100 years ago.

An option contract gives the buyer the right to BUY (call option) or SELL (put option) a specific stock or asset at a given price until the expiration date.

American style options allow the option owner to execute the contract at any time up until the expiration date, while European style options can only be exercised on the expiration date.

When an option contract is exercised or put into effect, the owner of the option contract assigns an action to the option seller.

• CALL options assignment requires the option seller to sell 100 shares of the underlying stock to the option buyer at the strike price.
• PUT options assignment requires the option seller to buy 100 shares of the underlying stock to the option buyer at the strike price.

Unlike futures contracts which come with an obligation to execute the agreement, options contracts give the option holder the choice whether they want to execute the agreement or not.

This contract gives the buyer the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) the underlying stock.

Now that we understand the basics, let's break down exactly how assignment works for both call and put options Here’s how it all works in a nutshell.

Call Option Assignment

1. I sell a call option contract for stock ABC to someone with a strike price of $50 that expires in 90 days.
2. That person now has the right to force me to sell them 100 shares of ABC stock at $50 until expiration.
3. The option holder will want to exercise the contract if:
   • The price of stock ABC is above $50.
   • There is very little extrinsic value left to the option.
4. When the option holder exercises the contract, I am assigned the obligation to sell 100 shares of stock ABC at $50.
5. If I don’t already own the stock, your broker will short the stock on your behalf to fulfill the option contract.

Put Option Assignment

1. I sell a put option contract for stock ABC to someone with a strike price of $50 that expires in 90 days.
2. That person now has the right to force me to buy 100 shares of ABC stock at $50 until expiration.
3. The option holder will want to exercise the contract if:
   1. The price of stock ABC is below $50.
   2. There is very little extrinsic value left to the option.
4. When the option holder exercises the contract, I am assigned the obligation to buy 100 shares of stock ABC at $50.
5. Your broker will debit your account for 100 shares x $50 = $5,000 to buy the stock on your behalf to fulfill the option contract.

While these examples outline the mechanics of assignment, timing is equally crucial. Let's explore the specific circumstances that typically trigger assignment.

When Does Options Assignment Occur?

While there are no hard and fast rules that say when an options seller will face assignment, there are certain scenarios that increase the odds it will happen.

Using Barchart's options chain, you can monitor key metrics like volume, open interest, and implied volatility to help assess potential assignment risk.

Options Assignment Deep In the Money

Let's continue with our ABC stock example to understand exactly when and why options assignment happens.

Remember that $50 strike price call option we sold?

While the buyer can exercise it at any time before expiration (assuming it's an American-style option), they're most likely to do so under specific circumstances.

The first and most common scenario occurs when an option is deep in-the-money with very little time value remaining.

Let's say ABC stock rises to $60. Our $50 call option now has $10 of intrinsic value ($60 current price - $50 strike price).

If there's only a few cents of time value left, the option buyer has little reason to wait. They can exercise their right to buy shares at $50, immediately sell them at $60, and lock in their profit.

Options Assignment and Dividends

Dividends present another crucial trigger for early assignment.

Imagine ABC announces a $0.75 per share quarterly dividend, and the ex-dividend date is approaching.

If our call option only has $0.50 of time value remaining, the option holder might exercise early to capture the dividend.

Why?

Because they'd lose more in missed dividend income ($0.75) than they'd give up in time value ($0.50).

The Nuts and Bolts of Options Assignment

When assignment happens, the process is handled by the Options Clearing Corporation (OCC).

Think of the OCC as the central hub that keeps the options market running smoothly.

When an option holder decides to exercise their contract, the OCC doesn't look for the specific person who sold them that option. Instead, they randomly select someone who's short that same option series.

It's similar to how a bank handles withdrawals - they don't give you back the exact same dollars you deposited, but rather an equivalent amount from their general pool.

For most traders, American-style stock options are the norm, which means assignment can occur any time before expiration.

This differs from index options like the S&P 500 (SPX), which are typically European-style and can only be exercised at expiration.

This distinction is crucial because with American-style options, you need to be prepared for assignment at any time, particularly when certain conditions align.

Understanding how assignment works through the OCC is important, but knowing how to manage and potentially avoid assignment is even more crucial for your trading success.

Let's explore how to use Barchart's tools to manage this risk effectively.

Managing Options Assignment Risk

Before your options contract is assigned, you have two options: close the option by buying it back at the market price or rolling the option.

Rolling combines both closing your current position and opening a new one in a single strategy.

When you roll an option, you're simultaneously buying back your current option and selling a new one with either a different strike price, expiration date, or both.

This strategy allows you to adjust your position as market conditions change while maintaining your overall market exposure.

Let's walk through a real-world example using Tesla (TSLA) and Barchart's advanced options tools to see exactly how this works.

Rolling Stock Options

Imagine you previously sold a covered call with a $325 strike price expiring this week. Looking at Barchart's option chain for TSLA, we can see the stock is trading at $339.91.

First we want to calculate the intrinsic and extrinsic value of the option to get a sense of how likely we are to face options assignment risk.

To get the intrinsic value of the $325 call option we take Tesla’s current price subtract the strike price: $339.91 - $325 = $14.91.

To get the extrinsic value of the call option we take the current bid price and subtract the intrinsic value: $15.80 - $14.91 = $0.89.

This means that you have $0.89 left of premium for time decay to eat away before expiration.

Given the price of the stock and it’s volatility, there’s a high risk you’ll face options assignment in the next day or two.

This leaves you with tough decision: either let your shares get called away at $325 and make that $0.89 per share or roll your position and try to capture more premium or price appreciation.

You see, we know that options with expiration dates farther into the future have higher extrinsic values.

We can use this to either collect more premium for the same strike or use that premium to “pay” to move the strike price higher.

Here’s how this could work.

Rolling for a credit:

1. Buy back the $325 call option expiring in two days for $15.80
2. Sell the $325 call option expiring in nine days for $20.80
3. Receive an additional credit of $20.80 - $15.80 = $5.00

Rolling into a higher strike price:

1. Buy back the $325 call option expiring in two days for $15.80
2. Sell the $332.50 call option expiring in nine days for $16.15
3. Receive an additional credit of $16.15 - $15.80 = $0.35
4. The intrinsic value of the option drops from $14.91 to $7.41

You reduce your risk of options assignment by pushing out the expiration date and either adding more premium or reducing how far in-the-money the call option is.

The best part is you can keep doing this over and over. However, if you are too far in-the-money, there won’t be enough extrinsic value on your option or one in the future that makes rolling worthwhile.

Finding the Right Roll

There is no hard and fast rule for where and how to roll your option to avoid assignment.

However, this is where Barchart's tools really shine.

Using the option chain's visual layout and customizable columns, you can easily compare different rolling opportunities. For example, you might notice:

1. Strike Price Choices: The color-coded moneyness indicators help you quickly identify which strikes might make suitable rolling targets.
2. Volume and Open Interest: These columns show you where other traders are focusing their activity, helping you find strikes with good liquidity.
3. Greeks: Delta values help you understand the probability of your new strike being reached.

Final Thoughts

Options assignment is a fundamental part of options trading that every investor needs to understand. While it may catch new traders off guard, assignment becomes predictable once you understand when and why it occurs.

By monitoring your positions using Barchart's suite of options tools and staying alert to key triggers like dividend dates and deep in-the-money options, you can transform assignment risk from a source of stress into a manageable aspect of your trading strategy.

Remember: The key to successful options trading isn't avoiding assignment entirely, but rather understanding when it might occur and being prepared to respond effectively when it does.

FAQ:

What is options assignment?

Assignment occurs when an options buyer exercises their contract, requiring the seller to fulfill their obligation to buy or sell shares at the strike price.

When does options assignment typically occur?

Assignment most commonly happens when options are deep in-the-money with minimal extrinsic value, or before ex-dividend dates when the dividend exceeds the remaining time value.

Can I avoid options assignment?

Yes, you can avoid assignment by closing your position before expiration or rolling to a different strike price or expiration date. However, once you're assigned, you must fulfill the contract obligations.

What's the difference between American and European style options assignment?

American-style options can be exercised any time before expiration, while European-style options can only be exercised at expiration.