Options are complex financial instruments, and understanding them fully can be challenging, especially for beginners. This article will explain what "exercise" and "assignment" mean in the context of options, as well as the fees associated with these processes. Firstly, let's define options. Stock options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price before the contract expires. Most brokers offer options trading, but you should check whether your broker does and what fees they charge. Here’s a quick example to explain options: Imagine you're interested in ABCD Corporation, which is currently priced at $25 per share. You believe the price will rise, so you buy a call option for $150 to purchase 100 shares at $35 each, one month from now. If the share price doesn’t reach $35 by the expiration date, you lose the $150 you paid for the option. But if the price exceeds $35, you can buy the shares at the lower price, potentially making a profit. For instance, if the share price reaches $45: - You buy 100 shares at $35 each = $3,500 (strike price) - The current market price is $45 per share x 100 = $4,500 - Your profit is $1,000 minus the $150 paid for the option - Total net profit is $850 Options can provide significant profits from a relatively small investment. Now, let’s discuss "exercise" and "assignment." When an option is exercised, the buyer of a call option buys the stock, while the seller of a put option sells the stock. The Options Clearing Corporation (OCC) regulates these transactions in the U.S., ensuring that everything runs smoothly when options are exercised. Assignment occurs when an option holder is required to fulfill the obligation of their contract, like selling shares at the agreed strike price. Here's what you need to know about fees: When you exercise an option, you decide to buy (or sell) the stock at the agreed price. Assignment happens when you're chosen to fulfill the opposite side of the option's contract, like providing the shares. Historically, brokers charged fees for these services, but many now offer them for free as part of their move towards lower costs. TradeStation, for example, charges $14.95 for both exercises and assignments. When choosing a broker, consider not just their fees but their overall services. Webull, for instance, offers commission-free options trading and excellent resources for investors. Here’s a quick overview of standard options fees at some popular brokers: - - $0 per options trade, $0.65 per contract - - $0 per options trade, $0.25-$0.65 per contract - - $0 per options trade, $1 per contract (opening trades only) - - $0 per options trade, $0.65 per contract - - $0 per options trade, $0 per contract Assignment and exercise fees are rare today, but you should still check with your broker about potential costs. Options trading can be risky, so it's important to understand all aspects before getting started. Options trading isn't for beginners. Make sure you fully understand how to trade options and any associated fees. Fortunately, fewer brokers charge these fees today, making options trading more accessible. However, always proceed with caution and consider all costs involved. |
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Last updated on February 11th, 2022 , 06:38 am
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.
Let’s look at some specific examples to drill down on this concept.
In the following table, we’ll examine how various options convert to stock positions for the option buyer and seller:
As you can see, exercise and assignment is pretty straightforward: when an option buyer exercises their option, they purchase (calls) or sell (puts) 100 shares of stock at the strike price . A trader who is short the assigned option is obligated to fulfill the opposite position as the option exerciser.
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.
Even if you don’t have enough capital in your account, you can still be assigned or automatically exercised into a stock position. For example, if you only have $10,000 in your account but you let one 500 call expire in-the-money, you’ll be long 100 shares of a $500 stock, which is a $50,000 position. Clearly, the $10,000 in your account isn’t enough to buy $50,000 worth of stock, even on 4:1 margin.
If you find yourself in a situation like this, your brokerage firm will come knocking almost instantaneously. In fact, your brokerage firm will close the position for you if you don’t close the position quickly enough.
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.
The following table demonstrates the losses from exercising an option with various amounts of extrinsic value:
As we can see here, 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. F
or 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!
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:
If you’d like, you can read the OCC’s detailed assignment procedure here (warning: it’s intense!).
Now you know how the assignment procedure works. In the final section, we’ll discuss how to quickly gauge the likelihood of early assignment on short options.
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.
The following scenarios summarize broad generalizations of early assignment probabilities in various scenarios:
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!
Additional resources.
Exercise and Assignment – CME Group
Learn About Exercise and Assignment – CME Group
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Video summary (1 and a half minutes).
The closing price of the stock on expiry establishes which options finish in the money and subject to exercise or assignment or those that finish out of the money, and worthless. Because option spreads involve both buying and selling of options, if the entire spread finishes out of the money, it either expires worthless, with nothing exercised or assigned. If a spread finishes completely in the money, it expires at its max value, with the options exercised and assigned, canceling each other out, and profits or losses determined. However, if only part of a spread is in the money, the position runs the risk of being assigned or auto-exercised and a resulting stock position may occur. Therefore many investors close spreads before expiry, if only part of the spread is in the money, or if the stock is close enough to the spread that that may occur.
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As your option contract approaches its expiration date, there are a few important things to keep in mind:
If your option expires in the money, Firstrade will typically attempt to exercise it for you at expiration unless:
If you have a Long Call about to expire:
If you have a Long Put about to expire:
If you have a spread about to expire:
Our Firstrade risk team monitors potential expiration risk throughout the day and periodically sends email notifications to accounts that have excessive potential expiration risk. Starting at 90 minutes before market close, the risk team will start to close out the (in the money / out of the money) expiring options positions that may be subject to potential exercise / assignment, depending upon account equity, buying power, and market conditions.
For Long Puts to be eligible for exercise, the underlying stock must be either held long in your account or available to short (listed under the Easy to Borrow List ). Generally, out-of-the-money option contracts expire worthless. However, the Out-of-the-Money (OTM) short options positions could potentially still get assigned, because after-hours price action can turn an OTM option into an “ITM option”, and the long option holders may request to exercise their long options even though their long option may have expired OTM based on the closing price.
You should review your account status for any contracts that you do not have sufficient buying power/shares to support the potential exercise/assignment; these contracts must be closed out at least 90 minutes before the market closes on the option expiration date, to avoid potential cash calls, margin calls, and forced liquidation with additional processing fees.
Note: If for any reason we can't sell your option contract, and your account doesn’t have the required buying power or shares to exercise it, we'll typically attempt to submit a Do Not Exercise request, and your option contract will expire worthless.
To determine if an option position is “at risk of being in the money,” Firstrade will calculate the Range of Price Shock, the potential magnitude of underlying stock price’s movement on the expiration date. If your option’s strike price falls within these parameters, it’s considered “at risk of being in the money”, and if your account doesn’t have the necessary buying power to cover the potential exercise/assignment, we’ll typically close out your option position.
The only way for you to eliminate this expiration risk is to close out short option position(s) at least 90 minutes before market close at expiration.
The following is a quick guide of what to expect when and if your options are exercised or assigned:
In The Money (ITM)
Note: Please keep in mind that an option contract being “In the Money” doesn’t necessarily mean that its holders will make a profit if they were to exercise it. For example, if you buy a strike price of $100 call option by paying a $5 premium, your call is in the money when the stock trades above $100, though you wouldn’t break even until it hits $105.
Out of The Money (OTM)
What happens if my option is out of the money at expiration?
If an option expires out of the money at expiration, the option becomes worthless. You may close it out before expiration to recoup any premium that is possibly remaining.
Note: Equity and ETF options are considered as In-the-money (ITM) / Out-of-the-money (OTM) based on the closing price of underlying stock or ETF at expiration.
If you have a long option that expires in the money (ITM) and do not want it to be exercised automatically, you need to submit a Do Not Exercise request before 4:30 PM ET on the option’s expiration date. You may follow the same instruction as listed above.
Do Not Exercise requests apply only to long option positions that expire in the money. If you have a short option that expires in the money, you cannot request Do Not Exercise. As a short option holder, you are obligated to deliver or take delivery of the assigned position for a short call or short put position, respectively.
If you have a long option that expires out of the money (OTM) and want to exercise it, you may submit an Exercise By Exception request by 4:30 PM EST on the option’s expiration date. You may follow the same instruction as listed above.
Exercise By Exception requests applies only to the long option positions that expire out of the money. If you have a short option that expires out of the money, you cannot request Exercise By Exception. As a short option holder, you are obligated to deliver or take delivery of the assigned position for a short call or short put position, respectively.
Exercise By Exception requests requires the account to have sufficient buying power to process an exercise request.
Note: All exercises & assignments are processed overnight.
There is no definitive way to know if you will be assigned or how many contracts will be assigned for the short options positions in your account until the next morning after the counterparty’s exercise request is processed. The long leg of your spread will not be automatically exercised if you were assigned early. The long option may only get automatically exercised when it expires in the money.
When you are assigned, you have the obligation to fulfill the terms of the contract. When you sell-to-open an option contract (short option), you can typically get assigned at any time prior to expiration, regardless of the underlying share price.
Depending on the collateral being held for your short option contract, there are a few different scenarios that could happen when you’re assigned before expiration.
1. If you’re assigned on a covered call: The shares you have as collateral will be sold to settle the assignment. No additional action is necessary.
2. If you’re assigned on a cash-secured put: The buying power that’s previously deducted as collateral will be used to purchase shares to settle the assignment. No additional action is necessary.
3. If you’re assigned on the short leg of a call spread: When you are assigned, you have the obligation to sell shares of the underlying stock at the strike price, which may result in a short stock position in an account. In this case, the long leg (you bought to open) should provide the collateral needed to cover the short leg. However,
A. If your long leg is In-the-money (ITM) The long leg of your spread may be exercised to purchase the shares needed to settle the assignment if a margin call occurs.
B. If your long leg is Out-of-the-money (OTM) You may have to purchase the shares needed from the market to cover the short stock position if a margin call occurs.
4. If you are assigned on the short leg of a put spread: When you are assigned, you have the obligation to buy shares of the underlying stock at the strike price, which may decrease buying power or result in an account deficit. In this case, the long leg (you bought to open) should provide the collateral needed to cover the short leg. However,
A. If your long leg is In-the-money (ITM) The long leg of your spread may be exercised to sell the assigned shares at the strike price to cover the account deficit/margin call due to the assignment of the short leg.
B. If your long leg is Out-of-the-money (OTM) You may have to sell the shares to the market if there is an account deficit / a margin call that occurs due to the assignment of the short leg.
Note: All exercises & assignments are processed overnight. There is no definitive way to know if you will be assigned or how many contracts will be assigned for the short options positions in your account until the next morning after the counterparty’s exercise request is processed. The long leg of your spread will not be automatically exercised if you were assigned early. The long option may only get automatically exercised when it expires in the money.
One of the biggest risks of options trading is dividend risk. If your account has any short call options (covered call or call spread position), there is a risk that you’ll get assigned on your short call options the night before the ex-dividend date.
When this happens to your covered call position, the shares you have as collateral will be called away (100 shares per contract) and you will lose the dividend payment.
When this happens to your call spread position, your account will have a short stock position (100 shares per contract) on the ex-dividend date; and you will actually be responsible for paying that dividend on the payable date.
You can avoid this by closing your option position before the market closes at 4 PM Eastern Time on the day before the ex-dividend date.
In order to receive the dividend for a stock, you need to purchase the shares or exercise the long call option before the ex-dividend date and hold the shares until the ex-dividend date to be entitled to the dividend.
Note: On the trading day before the ex-dividend date, we will check if your account has enough buying power to cover the dividend that you may probably have to pay to the other party when the short leg of your spread position may potentially get assigned. If your account does not have enough buying power to cover the dividend payment, we would typically attempt to close out your spread position before the market closes at 4 PM Eastern Time on the day before the ex-dividend date in order to help reduce the risk in your account.
Let’s say, ABC will pay out the following dividend:
If you have a covered call or a call spread position for ABC that is expiring on 09/18/2020, there is a risk that you will be assigned the night before the ex-dividend date.
If you get assigned on 09/17/2020 when the market opens on 09/18/2020, 100 shares of ABC stock position that you have as collateral would have been sold at the strike price to the counterparty (a person who bought and exercised the call option). No action needed to be taken.
If you get assigned on 09/17/2020, when the market opens on 09/18/2020, you will have a short position of 100 shares of ABC that were exercised by the counterparty (a person who bought and exercised the call option). In this case, you’ll have to pay the dividend that is associated with these shares to the other party.
In this example, you’ll owe $2 x 100 shares = $200. We’ll automatically deduct the dividend amount from your account on the payable date, even if it causes you to have a negative cash balance. We would typically attempt to buy back the shares to cover the short stock position if a cash call or margin call occurs on the ex-dividend date.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Firstrade does not guarantee favorable investment outcomes and there is always the potential of losing money when you invest in securities or other financial products. Investors should consider their investment objectives and risks carefully before investing. To learn more about the risks associated with options, please read the Characteristics and Risks of Standardized Options before you begin trading options. Please also be aware of the risks listed in the following documents: Day Trading Risk Disclosure Statement and FINRA Investor Information . Examples contained in this article are for illustrative purposes only. Supporting documentation for any claims, if applicable, will be provided upon request.
It has been said that for every action (exercise) there is a reaction (assignment). examine the process of option exercise and assignment..
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Exercise and assignment.
When a stock option is exercised, the call holder buys the stock, and the put holder sells stock. When options are exercised, the OCC decides to which brokerage firm, such as TastyWorks , the exercise will be assigned, and the brokerage in turn decides which customer will get the assignment.
When we are assigned an exercise and are required to sell our shares, the shares sold are said to have been called out or called away . Assignment occurs, then the shares are called out. Assignment on a short put means purchasing the stock.
Assignment is completely random, and an exercise can be assigned to and apportioned among several different call writers. Once assignment by OCC occurs, settlement between the buying and selling parties is automatic. Shares must be physically delivered once exercise occurs.
The covered call writer doesn’t have to do anything; the call writer’s broker handles settlement, delivers the shares and collects the exercise funds. Option exercise or assignment can be partial: one can exercise less than all the options held. Conversely, you may be assigned on less than all your short calls or puts.
However, one cannot exercise or be assigned on part of a single option contract . If you buy a call (put), you are not required to buy (sell) the underlying stock; you may sell the option to close or allow it to expire worthless.
Automatic Exercise
The OCC automatically exercises options that are $0.01 or more ITM, unless the option holder has notified his/her broker not to allow exercise of the option.
Note that a stock’s price can tick up or down after the close on expiration Friday, resulting in calls or puts (but not both calls and puts, obviously) that were near the money at Friday’s close becoming in the money – and being exercised.
If you are long calls on expiration Friday, you could find yourself purchasing shares unexpectedly, due to a late-day or after-market tick up in the stock.
Or if instead long the puts then, you might find yourself selling shares unexpectedly; and if you don’t own the underlying shares, this would either create a short stock position in your account, or your broker would buy you in (purchase the shares on your behalf) in order to cover itself.
Be sure your broker knows your wishes if you are long options at expiration and have not closed them. Writers of short calls and puts can similarly find themselves assigned an exercise due to the same mechanism.
Because stock options are American-style, you can be assigned an exercise any time an option is in the money, although options typically are not exercised early while there is still time value remaining.
The reason is that the exercise of an option forfeits its time value; to capture the time value it is necessary to flip (sell) the option. But as expiration draws near, options that are in the money sometimes trade at parity, and this is when early exercise occurs.
Options trading below parity practically beg arbitrageurs to exercise them for risk-less profit. This subject is covered in more detail in the chapter on Portfolio Writing.
60% – are traded out (sold or bought to close)
30% – expire worthless
10% – are exercised
Source: Chicago Board Options Exchange (CBOE)
Option traders like to say that only 10% of options are exercised, which is generally true, though not true in all cases. Thus if you write a call, the odds against assignment are roughly 9:1, statistically speaking.
But if a call is written ITM, the odds are quite high it will be exercised, despite the overall 9:1 odds. No matter where written originally, if the calls are in the money (ITM) $0.01 or more at expiration, exercise is a virtual certainty.
ATM and OTM options are never exercised, since it is cheaper to buy or sell the stock in the open market than to exercise an option.
The premium is the price paid or received for an option. Options are traded much like stocks, with bid and asked prices shown:
Example: A stock is trading at $30, and the July 30 Call prices are quoted as follows:
Bid = 1.65 Asked = 1.70
This means the high bidder will pay $1.65, and the lowest price offered to buyers is $1.70. Note the 0.05 spread between the two prices.
Actually, the only time the seller can be assured of getting the bid price, or the buyer paying only the asked price, is to enter the trade order as a market order , in which case they get the market price at the time the order is executed.
Market makers have to execute a market order at market price, up to the number of contracts for which the bid or offer is good, but are not obligated to take limit orders. By using a limit order, the seller might get 1.70 or even 1.75 for writing the call. And the buyer can enter a limit order for less than 1.70 (ex: 1.65), in an attempt to buy the call more cheaply.
Historically, the premium referred to the total amount received for selling the contract, not to the option price. However, today the term “premium” simply means the option’s price on a per-share basis. That is, if the premium shown is bid at $0.80, that means $0.80 per share; you would expect to receive $80.00 ($0.80 x 100) for an entire option contract relating to 100 shares when using a market order. As we are about to see, premium is not just premium. The premium can be all intrinsic value, all time value, or contain both.
Intrinsic value is the portion of the premium that is in the money. Intrinsic increases dollar-for-dollar with the stock price as it moves. Only ITM calls have intrinsic value.
Intrinsic value = total premium – time value
Time Value is the portion of the premium that is not in the money. It is also known as “ extrinsic value ”. Time value is the amount upon which return is calculated in covered call writing. ATM and OTM premium is all time value. Time value = premium – intrinsic value.
Time value = total premium – intrinsic value
Calculating intrinsic and time value is simple. First, calculate the intrinsic value part of the premium. The remainder is time value. The entire premium of an ATM and OTM call will always be 100% time value. The following examples illustrate how to determine intrinsic and time value. In both examples assume the stock price is $20.
Example 1: ITM 17.50 Call – premium is $3.50:
Calculating Intrinsic Value | Calculating Time Value | |||
XYZ Stock price | 20.00 | Total premium | 3.50 | |
– Strike price | (17.50) | – Intrinsic value | ( 2.50) | |
Example 2: ATM 20 Call – premiums is $1.00:
Calculating Intrinsic Value | Calculating Time Value | |||
XYZ Stock price | 20.00 | Total premium | 1.00 | |
– Strike price | (20.00) | – Intrinsic value | ( 0) | |
Somehow, financial writers manage to make it sound as though the intrinsic value is the “real” or valuable part of the premium. Not so for the option seller!
The profit in covered call return calculations lies solely in the time value. Suppose for example that when the stock is $32.50 you were to write the 30 Call for a $3.00 premium, which seems fat.
But if assigned at the $30 strike price, you must sell the stock for $30. Thus your return will be the time value amount, which was only $0.50 (3.00 – 2.50 intrinsic value). Think of the intrinsic value as your money ; when selling the call, the intrinsic portion really is an advance payment of your money, since you could sell the stock and get the intrinsic amount immediately.
Note above in the intrinsic value definition that I said it increases dollar-for-dollar with the stock price. I am referring to the intrinsic value only. Suppose a stock is $30 and the current-month 30 Call can be sold for $1.25; obviously, the entire premium is time value since the call is not ITM.
If the stock moves up $1.00 to $31, the total premium may only increase $0.50 (to $1.75), not dollar-for-dollar with the stock. In this example, time value actually shrank from $1.25 to $0.75 with the stock’s rise. The 30 Call originally had $1.25 of time value, but the stock’s $1.00 price rise reduced the time value to $0.75 since the call is now $1.00 ITM.
Parity simply means that the option is trading precisely at intrinsic value and refers only to ITM options, since only they have intrinsic value. Options seldom trade more than a few pennies below parity (sub-parity). ITM options tend to trade at parity when:
Characteristics of the Three Call Strikes
ATM calls (at-the-money calls), which are all time value, offer the most time value premium and the largest returns. They also provide a reasonable degree of downside protection should the stock price drop. ATM options usually are the most heavily traded because they are worth more to the market. Why? The trader is not paying for intrinsic value.
OTM calls (out-of-the-money calls), which also are all time value, offer less time value premium than ATM calls and provide the least downside protection. OTM time value premium usually is higher than for ITM calls, at least in flat or rising markets.
ITM calls (in-the-money calls) usually offer the least time value premium, especially in a rising market, but the biggest downside protection. On a falling stock, though, their time value premium can be comparable to or better than for OTM calls.
Throughout these articles, we will be referring to options as ITM, ATM or OTM. The easiest way to keep them straight is to learn them for call options. Then remember that ITM and OTM are the opposite for put options.
Time decay means that the time value portion of the option premium will shrink as time runs out. The intrinsic value portion of ITM calls never shrinks due to passage of time.
Time decay accelerates in the last 30 days of an option’s life, and the most rapid time decay occurs in the last 10 days. Time decay is one of the two reasons for writing calls in the current expiration month. (The other is premium compression , which means that the more time you sell, the less premium you receive per month sold.)
Stock does not expire and thus its price is not affected by the passage of time. The fact that options expire by their own terms means that they lose value at a steady rate (until the last 30 days, at any rate) – the time decay. Effects of time decay:
The following graph illustrates how an option loses value (decays) with the passage of time. Note the acceleration of time decay in the last 30 days and the very rapid acceleration in the last 10 days. Of course, it is the time value portion of option premium that decays; intrinsic value never decays.
Figure 2.6
The time remaining in days to expiration is an important time factor. In legal terminology, an option is a wasting asset (it expires naturally with time), and as the option’s expiration date gets closer, the value of the option decreases.
The more time remaining until expiration, generally the more time value the option contract has. If the underlying asset price falls far below or far above the strike price of the option, the price of underlying asset in relation to the strike price becomes more significant in determining the option’s price.
On the day the option expires, the only value the option contract has is its intrinsic value, if any (ITM options).
Theta is the expected change in an option premium for a single day’s passage of time. That is, if all other factors are not changed, then option premium should be lower the next trading day by the theta value. Theta, then, expresses time decay of an option’s time value.
>> More: Introduction To Options
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Options were originally traded in the over-the-counter ( OTC ) market , where the terms of the contract were negotiated. The advantage of the OTC market over the exchanges is that the option contracts can be tailored: strike prices, expiration dates, and the number of shares can be specified to meet the needs of the option buyer. However, transaction costs are greater and liquidity is less.
Option trading really took off when the first listed option exchange — the Chicago Board Options Exchange ( CBOE )— was organized in 1973 to trade standardized contracts, greatly increasing the market and liquidity of options. The CBOE was the original exchange for options, but, by 2003, it has been superseded in size by the electronic Nasdaq International Securities Exchange (ISE), based in New York. Most options sold in Europe are traded through electronic exchanges. Other exchanges for options in the United States include: New York Stock Exchange , and the NASDAQtrader.com .
Option exchanges are central to the trading of options:
Options are traded just like stocks — the buyer buys at the ask price and the seller sells at the bid price . The settlement time for option trades is 1 business day ( T+1 ). However, to trade options, an investor must have a brokerage account and be approved for trading options and must also receive a copy of the booklet Characteristics and Risks of Standardized Options .
The option holder, unlike the holder of the underlying stock, has no voting rights in the corporation, and is not entitled to any dividends. Brokerage commissions are still charged for options even though the commissions for stocks have been free for a while. Prices for most options range from $0.65 to $1 per contract .
The Options Clearing Corporation ( OCC ) is the counterparty to all option trades. The OCC issues, guarantees, and clears all option trades involving its member firms, including all U.S. option exchanges, and ensures that sales are transacted according to the current rules. The OCC is jointly owned by its member firms — the exchanges that trade options — and issues all listed options, and controls and effects all exercises and assignments. To provide a liquid market, the OCC guarantees all trades by acting as the other party to all purchases and sales of options.
The OCC, like other clearing companies, is the direct participant in every purchase and sale of an option contract. When an option writer or holder sells his contracts to someone else, the OCC serves as an intermediary in the transaction. The option writer sells his contract to the OCC and the option buyer buys it from the OCC.
The OCC publishes statistics, news on options, and any notifications about changes in the trading rules, or the adjustment of certain option contracts because of a stock split or that were subjected to unusual circumstances, such as a merger of companies whose stock was the underlying security to the option contracts.
The OCC operates under the jurisdiction of both the Securities and Exchange Commission ( SEC ) and the Commodities Futures Trading Commission ( CFTC ). Under its SEC jurisdiction, OCC clears transactions for put and call options on common stocks and other equity issues, stock indexes, foreign currencies, interest rate composites and single-stock futures . As a registered Derivatives Clearing Organization ( DCO ) under CFTC jurisdiction, the OCC clears and settles transactions in futures and options on futures .
When an option holder wants to exercise his option, he must notify his broker of the exercise, and if it is the last trading day for the option, the broker must be notified before the exercise cut-off time , which will probably be earlier than on trading days before the last day, and the cut-off time may differ for different option classes or for index options. Although policies differ among brokerages, it is the duty of the option holder to notify his broker to exercise the option before the cut-off time.
When the broker is notified, then the exercise instructions are sent to the OCC, which then assigns the exercise to one of its Clearing Members who are short in the same option series as is being exercised. The Clearing Member will then assign the exercise to one of its customers who is short in the option. The customer is selected by a specific procedure, usually on a first-in, first-out basis, or some other fair procedure approved by the exchanges. Thus, there is no direct connection between an option writer and a buyer.
To ensure contract performance, option writers are required to post margin, the amount depending on how much the option is in the money. If the margin is deemed insufficient, then the option writer will be subjected to a margin call. Option holders don't need to post margin because they will only exercise the option if it is in the money. Options, unlike stocks, cannot be bought on margin.
Because the OCC is always a party to an option transaction, an option writer can close out his position by buying the same contract back, even while the contract buyer retains his position, because the OCC draws from a pool of contracts with no connection to the original contract writer and buyer.
A diagram outlining the exercise and assignment of a call.
John Call-Writer writes an option that legally obligates him to provide 100 shares of JXYZ for the price of $30 until April. The OCC buys the contract, adding it to the millions of other option contracts in its pool. Sarah Call-Buyer buys a contract that has the same terms that John Call-Writer wrote — in other words, it belongs to the same option series . However, option contracts have no name on them. Sarah buys from the OCC, just as John sold to the OCC, and she just gets a contract giving her the right to buy 100 shares of JXYZ for $30 per share until April.
In February, the price of JXYZ rises to $35, and Sarah thinks it might go higher in the long run, but since March and April generally are volatile times for most stocks, she decides to exercise her call (sometimes called calling the stock ) to buy JXYZ stock at $30 per share to hold the stock indefinitely. She instructs her broker to exercise her call; her broker forwards the instructions to the OCC, which then assigns the exercise to one of its participating members who provided the call for sale; the participating member, in turn, assigns it to an investor who wrote such a call; in this case, it happened to be John's brother, Sam Call-Writer. John got lucky this time. Sam, unfortunately, either must turn over his appreciated shares of JXYZ, or he'll have to buy them in the open market to provide them. This is the risk that an option writer must take — an option writer never knows when he'll be assigned an exercise when the option is in the money.
John Call-Writer decides that JXYZ might climb higher in the coming months, and so decides to close out his short position by buying a call contract with the same terms that he wrote — one that is in the same option series. Sarah, on the other hand, decides to maintain her long position by keeping her call contract until April. This can happen because there are no names on the option contracts. John closes his short position by buying the call back from the OCC at the market price, which may be higher or lower than what he paid, resulting in either a profit or a loss. Sarah can keep her contract because when she sells or exercises her contract, it will be with the OCC, not with John, and Sarah can be sure that the OCC will fulfill the terms of the contract if she exercises it later.
Thus, the OCC allows each investor to act independently of the other .
When the assigned option writer must deliver stock, she can deliver stock already owned, buy it on the market for delivery, or ask her broker to go short on the stock and deliver the borrowed shares. However, finding borrowed shares to short may not always be possible, so this method may not be available.
If the assigned call writer buys the stock in the market for delivery, the writer only needs the cash in his brokerage account to pay for the difference between what the stock cost and the strike price of the call, since the writer will immediately receive cash from the call holder for the strike price. Similarly, if the writer is using margin, then the margin requirements apply only to the difference between the purchase price and the strike price of the option. Full margin requirements, however, apply to shorted stock.
An assigned put writer will need either the cash or the margin to buy the stock at the strike price, even if he intends to sell the stock immediately after the exercise of the put. When the call holder exercises, he can keep the stock or immediately sell it. However, he must have the margin, if he has a margin account, or cash, for a cash account, to pay for the stock, even if he sells it immediately. He can also use the delivered stock to cover a short in the stock. (Note: equity requirements differ because an assigned call writer immediately receives the cash upon delivery of the shares, whereas a put writer or a call holder who purchased the shares may decide to keep the stock.)
A call writer receives an exercise notice on 10 call contracts with a strike of $30 per share on JXYZ stock on which she is still short. The stock currently trades at $35 per share. She does not own the stock, so, to fulfill her contract, she must buy 1,000 shares of stock in the market for $35,000 then sell it for $30,000, resulting in an immediate loss of $5,000 minus the commissions of the stock purchase and assignment.
Both the exercise and assignment incur brokerage commissions for both holder and assigned writer. Generally, the commission is smaller to sell the option than it is to exercise it. However, there may be no choice if it is the last day of trading before expiration. Both the buying and selling of options and the exercise or assignment are settled in 1 business day after the trade ( T+1 ).
Often, a writer will want to cover his short by buying the written option back on the open market. However, once he receives an assignment, then it is too late to cover his short position by closing the position with a purchase. Assignment is usually selected from writers still short at the end of the trading day. A possible assignment can be anticipated if the option is in the money at expiration, the option is trading at a discount, or the underlying stock is about to pay a large dividend.
The OCC automatically exercises any option that is in the money by at least $0.01 ( automatic exercise , Exercise-by-Exception , Ex-by-Ex ), unless notified by the broker not to. A customer may not want to exercise an option that is only slightly in the money if the transaction costs would exceed the net profit from the exercise. Despite the automatic exercise by the OCC, the option holder should notify his broker by the exercise cut-off time , which may be before the end of the trading day, of an intent to exercise. Exact procedures depend on the broker.
Any option that is sold on the last trading day before expiration would likely be bought by a market maker. Because a market maker's transaction costs are lower than for retail customers, a market maker may exercise an option even if it is only a few cents in the money. Thus, any option writer who does not want to be assigned should close out his position before expiration day if there is any chance that it will be in the money even by a few pennies.
Sometimes, an option will be exercised before its expiration day — called early exercise , or premature exercise . Because options have a time value in addition to intrinsic value, most options are not exercised early. However, there is nothing to prevent someone from exercising an option, even if it is not profitable to do so, and sometimes it does occur, which is why anyone who is short an option should expect the possibility of being assigned early.
When an option is trading below parity (below its intrinsic value), then arbitrageurs can take advantage of the discount to profit from the difference, because their transaction costs are very low. An option with a high intrinsic value will have little time value, and so, because of the difference between supply and demand in the market at any given moment, the option could be trading for less than its true worth. An arbitrageur will almost certainly take advantage of the price discrepancy for an instant profit. Anyone who is short an option with a high intrinsic value should expect a good possibility of being assigned an exercise.
JXYZ stock is currently at $40 per share. Calls on the stock with a strike of $30 are selling for $9.80. This is a difference of $0.20 per share, enough of a difference for an arbitrageur, whose transaction costs are typically much lower than for a retail customer, to profit immediately by selling short the stock at $40 per share, then covering his short by exercising the call for a net of $0.20 per share minus the arbitrageur's small transaction costs.
Option discounts will only occur when the time value of the option is small, because either it is deep in the money or the option will soon expire.
When a large dividend is paid by the underlying stock, its price drops on the ex-dividend date, resulting in a lower value for the calls. The stock price may remain lower after the payment, because the dividend payment lowers the book value of the company. This causes many call holders to either exercise early to collect the dividend, or to sell the call before the drop in stock price. When many call holders sell at once, the calls sell at a discount to the underlying, creating opportunities for arbitrageurs to profit from the price difference. However, there is risk the transaction will lose money, because the dividend payment and drop in stock price may not equal the premium paid for the call, even if the dividend exceeds the time value of the call.
JXYZ stock is currently trading at $40 per share and will pay a dividend of $1 the next day. A call with a $30 strike is selling for $10.20, the $0.20 being the time value of the premium. So an arbitrageur decides to buy the call and exercise it to collect the dividend. Since the dividend is $1, but the time value is only $0.20, this could lead to a profit of $0.80 per share, but on the ex-dividend date, the stock drops to $39. Adding the $1 dividend to the share price yields $40, which is still less than buying the stock for $30 + $10.20 for the call. It might be profitable if the stock does not drop as much on the ex-date or it recovers after the ex-date sufficiently to make it profitable. But this is a risk for the arbitrageur, and this transaction is, thus, known as risk arbitrage , because the profit is not guaranteed.
Data Source: https://www.optionseducation.org/referencelibrary/faq/options-exercise
All option writers who didn't close out their position earlier by buying an offsetting contract made the maximum profit — the premium — on those contracts that expired. Option writers have lost at least something when the option is exercised, because the option holder wouldn't exercise it unless it was in the money. The more the exercised option was in the money, the greater the loss is for the assigned option writer and the greater the profits for the option holder. A closed out transaction could be at a profit or a loss for both holders and writers of options, but closing out a transaction is usually done either to maximize profits or to minimize losses, based on expected changes in the price of the underlying security until expiration.
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So your trading account has gotten options approval, and you recently made that first trade—say, a long call in XYZ with a strike price of $105. Then expiration day approaches and, at the time, XYZ is trading at $105.30.
Wait. The stock's above the strike. Is that in the money 1 (ITM) or out of the money 2 (OTM)? Do I need to do something? Do I have enough money in my account? Help!
Don't be that trader. The time to learn the mechanics of options expiration is before you make your first trade.
Here's a guide to help you navigate options exercise 3 and assignment 4 —along with a few other basics.
The buyer ("owner") of an option has the right, but not the obligation, to exercise the option on or before expiration. A call option 5 gives the owner the right to buy the underlying security; a put option 6 gives the owner the right to sell the underlying security.
Conversely, when you sell an option, you may be assigned—at any time regardless of the ITM amount—if the option owner chooses to exercise. The option seller has no control over assignment and no certainty as to when it could happen. Once the assignment notice is delivered, it's too late to close the position and the option seller must fulfill the terms of the options contract:
An option will likely be exercised if it's in the option owner's best interest to do so, meaning it's optimal to take or to close a position in the underlying security at the strike price rather than at the current market price. After the market close on expiration day, ITM options may be automatically exercised, whereas OTM options are not and typically expire worthless (often referred to as being "abandoned"). The table below spells it out.
The guidelines in the table assume a position is held all the way through expiration. Of course, you typically don't need to do that. And in many cases, the usual strategy is to close out a position ahead of the expiration date. We'll revisit the close-or-hold decision in the next section and look at ways to do that. But assuming you do carry the options position until the end, there are a few things you need to consider:
A note on pin risk : It's not common, but occasionally a stock settles right on a strike price at expiration. So, if you were short the 105-strike calls and XYZ settled at exactly $105, there would be no automatic assignment, but depending on the actions taken by the option holder, you may or may not be assigned—and you may not be able to trade out of any unwanted positions until the next business day.
But it goes beyond the exact price issue. What if an option is ITM as of the market close, but news comes out after the close (but before the exercise decision deadline) that sends the stock price up or down through the strike price? Remember: The owner of the option could submit a DNE request.
The uncertainty and potential exposure when a stock price and the strike price are the same at expiration is called pin risk. The best way to avoid it is to close the position before expiration.
As expiration approaches, you have three choices. Depending on the circumstances—and your objectives and risk tolerance—any of these might be the best decision for you.
1. Let the chips fall where they may. Some positions may not require as much maintenance. An options position that's deeply OTM will likely go away on its own, but occasionally an option that's been left for dead springs back to life. If it's a long option, the unexpected turn of events might feel like a windfall; if it's a short option that could've been closed out for a penny or two, you might be kicking yourself for not doing so.
Conversely, you might have a covered call (a short call against long stock), and the strike price was your exit target. For example, if you bought XYZ at $100 and sold the 110-strike call against it, and XYZ rallies to $113, you might be content selling the stock at the $110 strike price to monetize the $10 profit (plus the premium you took in when you sold the call but minus any transaction fees). In that case, you can let assignment happen. But remember, assignment is likely in this scenario, but it is not guaranteed.
2. Close it out . If you've met your objectives for a trade, then it might be time to close it out. Otherwise, you might be exposed to risks that aren't commensurate with any added return potential (like the short option that could've been closed out for next to nothing, then suddenly came back into play). Keep in mind, there is no guarantee that there will be an active market for an options contract, so it is possible to end up stuck and unable to close an options position.
The close-it-out category also includes ITM options that could result in an unwanted long or short stock position or the calling away of a stock you didn't want to part with. And remember to watch the dividend calendar. If you're short a call option near the ex-dividend date of a stock, the position might be a candidate for early exercise. If so, you may want to consider getting out of the option position well in advance—perhaps a week or more.
3. Roll it to something else . Rolling, which is essentially two trades executed as a spread, is the third choice. One leg closes out the existing option; the other leg initiates a new position. For example, suppose you're short a covered call on XYZ at the July 105 strike, the stock is at $103, and the call's about to expire. You could attempt to roll it to the August 105 strike. Or, if your strategy is to sell a call that's $5 OTM, you might roll to the August 108 call. Keep in mind that rolling strategies include multiple contract fees, which may impact any potential return.
You don't enter an intersection and then check to see if it's clear. You don't jump out of an airplane and then test the rip cord. So do yourself a favor. Get comfortable with the mechanics of options expiration before making your first trade.
1 Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the stock price is above the strike price. A put option is ITM if the stock price is below the strike price. For calls, it's any strike lower than the price of the underlying equity. For puts, it's any strike that's higher.
2 Describes an option with no intrinsic value. A call option is out of the money (OTM) if its strike price is above the price of the underlying stock. A put option is OTM if its strike price is below the price of the underlying stock.
3 An options contract gives the owner 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 at the strike price, on or before the option's expiration date. When the owner claims the right (i.e. takes a long or short position in the underlying security) that's known as exercising the option.
4 Assignment happens when someone who is short a call or put is forced to sell (in the case of the call) or buy (in the case of a put) the underlying stock. For every option trade there is a buyer and a seller; in other words, for anyone short an option, there is someone out there on the long side who could exercise.
5 A call option gives the owner the right, but not the obligation, to buy shares of stock or other underlying asset at the options contract's strike price within a specific time period. The seller of the call is obligated to deliver, or sell, the underlying stock at the strike price if the owner of the call exercises the option.
6 Gives the owner the right, but not the obligation, to sell shares of stock or other underlying assets at the options contract's strike price within a specific time period. The put seller is obligated to purchase the underlying security at the strike price if the owner of the put exercises the option.
7 When the stock settles right at the strike price at expiration.
8 Margin is borrowed money that's used to buy stocks or other securities. In margin trading, a brokerage firm lends an account owner a portion of the purchase price (typically 30% to 50% of the total price). The loan in the margin account is collateralized by the stock, and if the value of the stock drops below a certain level, the owner will be asked to deposit marginable securities and/or cash into the account or to sell/close out security positions in the account.
9 A margin call is issued when your account value drops below the maintenance requirements on a security or securities due to a drop in the market value of a security or when a customer exceeds their buying power. Margin calls may be met by depositing funds, selling stock, or depositing securities. Charles Schwab may forcibly liquidate all or part of your account without prior notice, regardless of your intent to satisfy a margin call, in the interests of both parties.
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Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the Options Disclosure Document titled " Characteristics and Risks of Standardized Options " before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.
With long options, investors may lose 100% of funds invested. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received.
Short options can be assigned at any time up to expiration regardless of the in-the-money amount.
Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss.
Commissions, taxes, and transaction costs are not included in this discussion but can affect final outcomes and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Short selling is an advanced trading strategy involving potentially unlimited risks and must be done in a margin account. Margin trading increases your level of market risk. For more information, please refer to your account agreement and the Margin Risk Disclosure Statement.
The main ways you can close your Option position(s) is by trading your contract, exercising it, letting it expire, or having your contract assigned.
Buying back a short position or selling a long position is the most common way investors choose to close out of their Option positions, especially if they are in-the-money. Because of the capital required to exercise an Options contract, many choose to close the contract before expiration, allowing them to realize any remaining time value left in the contract, and for those contracts in-the-money, any profits from the increase in the Option's intrinsic value without the need for additional capital or the worry about being short cash or shares.
When can I trade options?
The majority of Options contracts trade Monday - Friday from 9:30am to 4pm ET.
On the day of expiration, you’ll have until 3pm to open a same-day expiring contract, and until 3:30pm to close a same-day expiring contract. At 3:30pm ET, Public will automatically cancel any pending orders for same-day expiring contracts. Additionally, Public may start attempting to close out any same-day expiring positions that are at risk.
To understand at risk positions, refer to the ‘ What happens if I don’t have the shares or buying power to exercise? ‘ section below.
What does exercise mean?
Exercising essentially means executing your right to buy or sell the underlying equity at the strike price. You can choose to exercise your right any day up to or on the expiration date, which is called “early exercise.” Or, if you don’t take action, your Option contract will be automatically exercised at expiration if it is at least one penny in-the-money—a process referred to as the "exercise by exception" by the Options Clearing Corporation.
What happens if I exercise?
Exercising an Options contract depends on the type of Option you own. If you own a call Option, by exercising the contract, you agree to buy shares at the strike price. If you own a put Option, by exercising, you agree to sell shares you own at the strike price. For example, if you’re exercising a call Option that involves buying $10,000 worth of stock, you’ll need $10,000 in your buying power to complete the trade—even if you plan to immediately sell the stock. For a put Option, you would need to own the shares you are obliged to deliver or else you would wind up short all of those shares and be in a precarious situation, forced to buy them back at a future price.
How do I exercise?
If your Option is in-the-money at expiration - even if only by one penny - your contract will automatically exercise at expiration, except in certain circumstances where Public must get involved to mitigate risk.
You can also exercise your Options early, prior to expiration. To exercise early, reach out to Public’s customer support team either via the Chat or by emailing [email protected] , who will submit the exercise request on your behalf. Please include:
Action statement: “I would like to exercise the following Options:”
Followed by:
Contract (Symbol, Strike price, Expiration date, Call/Put)
Quantity you wish to exercise
Your account number
Any exercise requests after 4pm will be automatically queued for the next trading day, unless it’s on the day of expiration. The exercise request is processed overnight, and your position and balances will be updated on the next business day. Coming soon, you’ll be able to directly exercise your Option in the app.
What happens if I don’t have the shares or buying power to exercise?
It is important to remember that contracts at least one penny in-the-money will automatically exercise at expiration. Given this, if you do not have the necessary buying power or shares, it’s important that you attempt to close that position prior to 3:30pm ET on day of expiration. Remember, it is your responsibility to actively manage the risks associated with your Options positions.
At 3:30pm ET on the day of expiration, if your contract is in-the-money and you do not have the necessary buying power or shares, Public will attempt to liquidate the position on your behalf to prevent you from going into a negative debit balance or being short shares. If for any reason we can’t sell your contract, and you don’t have the necessary buying power or shares to exercise the contract, Public may attempt to submit a Do Not Exercise request to the Options Clearing Corporation (OCC).
What is a do not exercise (“DNE”) request?
A DNE request is when you ask the OCC to not exercise your Options contract - having it expire worthless. You may ask Public to submit a DNE request on your behalf, or in certain instances, Public may submit one of your behalf as a last resort. DNE requests are typically used by investors as a last resort after they’ve had other failed attempts to close out their in-the-money long Option position, and do not want the contract to exercise.
To submit a do not exercise request, email [email protected] with the subject ‘DNE request’ on the day of expiration. In the email, please include:
Action statement: “I would like to submit a do not exercise for the following Options:”
Public’s cut-off time for submitting a do not exercise request on your behalf is 4:30pm ET on the day of expiration. All requests submitted are processed on a best-effort basis. Failure to submit a DNE request before our cutoff time may result in in-the-money contract(s) being exercised automatically.
It’s also important to note that even if you submit a DNE request, your position may still be liquidated on the day of expiration.
What is expiration?
Each Option contract comes with an expiration date that is determined at the creation of the contract itself. An Option’s expiration date is the last day you can exercise your right to buy or sell the underlying stock at the agreed-upon strike price. If you hold your contract until expiration, and it is either out-of-the-money or in-the-money but you submitted a DNE, the Option will expire worthless. Or in other terms, after the expiration date, the Option contract becomes null and void (has zero value) and is no longer tradeable.
How would my contract expire?
Contracts typically expire in two scenarios. The first, if you (or in select circumstances, Public) submit a do not exercise request. Or, the second, when a contract becomes essentially worthless - the open interest and price drop close to 0.
What does assignment mean?
Assignment refers to the obligation of an Option seller to fulfill the contract's terms when the option holder, or buyer, chooses to exercise their right. Option sellers are often referred to as option writers, or being short the contract.
When an option holder chooses to early exercise, what are the steps to assignment?
Decision to exercise: Option holders may choose to exercise early when market conditions align, potentially fearing a reversal in stock prices that could erode profits, or wanting to capitalize on an upcoming dividend.
Initial notification: The Options Clearing Corporation is informed upon early exercise, randomly assigning a brokerage client who is short a matching Option.
Assignment notification: The short Option holder is notified by their brokerage about being assigned and is now responsible for meeting the Option contract's terms.
Fulfilling the obligation: Option writers must deliver the underlying asset for call Options or pay for the underlying asset for put Options. This is typically an automated process carried out by brokerages.
Aside from early exercise, when else can assignment happen?
As an Option writer, there is risk of assignment up until expiration. This is because any Option contract that is in-the-money at the time of expiration will be automatically exercised, even if it is only in the money by $0.01, unless the Option owner specifically requests to have it not exercised.
Can you provide an example of an assignment?
Let’s take a basic example. Say you've sold a call Option on FlyFit at $50, and sometime after the stock rises to $60. Seeing this favorable condition, a person who bought an Option with the same conditions decides to exercise their right to buy FlyFit shares at $50.
This triggers a notification to the Options Clearing Corporation, which randomly selects a member brokerage, who then randomly nominates you as the Option writer, as you’re short this specific type of contact.
From there, we’ll get in touch and notify you that you’ve been assigned and are now responsible for delivering FlyFit shares at the agreed $50 strike price to the Options holder. In exchange for delivering the shares, you will be paid $50 per share from the Options holder.
When am I at risk of assignment?
Selling Options always carries the possibility of assignment, which is particularly risky if you lack the necessary shares or capital. Preparedness is crucial to navigate potential challenges.
As an investor, you can mitigate assignment risks by buying to close out your positions well before expiration, particularly if the Option is approaching an in-the-money status, providing more control and potential savings.
Additionally, it is important to pay attention to a company’s earnings and dividend dates, as during those times, the risk of assignment may be heightened.
For further questions contact Member Support via in-app chat or email at [email protected] .
Options carry significant risk and are not suitable for all investors. Options investors can rapidly lose the value of their investment in a short period of time and incur permanent loss by expiration date. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options. Supporting documentation for any claims will be furnished upon request. Prior to buying or selling an option, investors must read and understand the “Characteristics and Risks of Standardized Options,” which can be found at: public.com/ODD . See full terms of the Options Order Flow Rebate Program at public.com/disclosures/rebate-terms . Rebate rates are subject to change for new and existing enrollees .
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If you are learning about options, assignment might seem like a scary topic. In this article, you will learn why it really isn’t. I will break down the entire options assignment process step by step and show you when you might be assigned, how to minimize the risk of being assigned, and what to do if you are assigned.
Check out the following video in which I explain everything you need to know about assignment:
To understand assignment, we must first remember what options allow you to do. So let’s start with a brief recap:
In other words, call options allow you to call away shares of the underlying from someone else, whereas a put option allows you to put shares in someone else’s account. Hence the name call and put option.
The assignment process is the selection of the other party of this transaction. So the person that has to buy from or sell to the option buyer that exercised their option.
Note that an option buyer has the right to exercise their option. It is not an obligation and therefore, a buyer of an option can never be assigned. Only option sellers can ever be get assigned since they agree to fulfill this obligation when they sell an option.
Let’s go through a specific example to clarify this:
Over the next few weeks, ABC’s price goes down to $90 and Peter decides to exercise his put option. This means that he uses his right to sell 100 shares of ABC for $95 per share. Now Kate is assigned these 100 shares of ABC which means she is obligated to buy them for $95 per share.
Peter now has 100 fewer shares of ABC in his portfolio, whereas Kate has 100 more.
This process is analog for a call option with the only difference being that Kate would be short 100 shares and Peter would have 100 additional shares of ABC in his portfolio.
Hopefully, this example clarifies what assignment is.
To answer this question, we must first ask ourselves who exercises their option? To do this, let’s quickly look at the different ways that you can close a long option position:
So as an option seller, you only have to worry about the last two possibilities in which the buyer’s option is exercised.
But before you worry too much, here is a quick fact about the distribution of these 3 alternatives:
Less than 10% of all options are exercised.
This means 90% of all options are either sold prior to the expiration date or expire worthless. So always remember this statistic before breaking your head over the risk of being assigned.
It is very easy to avoid the first case of being assigned. To avoid it, just close your short option positions before they expire (ITM). For the second case, however, things aren’t as straight forward.
Firstly, you have to be trading American-style options. European-style options can only be exercised on their expiration date. But most equity options are American-style anyway. So unless you are trading index options or other kinds of European-style options, this will be the case for you.
Secondly, you need to be an options seller. Option buyers can’t be assigned.
These two are necessary conditions for you to be assigned. Everyone who fulfills both of these conditions risks getting assigned early. The size of this risk, however, varies depending on your position. Here are a few things that can dramatically increase your assignment risk:
Since you now know what assignment is, and who risks being assigned, let’s shift our focus on how to minimize the assignment risk. Even though it isn’t possible to completely remove the risk of being assigned, there are things that you can do to dramatically decrease the chances of being assigned.
The first thing would be to avoid selling options on securities with upcoming dividend payments. Before putting on a position, simply check if the underlying security has any upcoming dividend payments. If so, look for a different trade.
If you ever are in the position that you are short an option and the ex-dividend of the underlying security is right around the corner, compare the size of the dividend to the extrinsic value of your option. If the extrinsic value is less than the dividend amount, you really should consider closing the position. Otherwise, the chances of being assigned are high. This is especially bad since being short during a dividend payment of a security will force you to pay the dividend.
Besides avoiding dividends, you should also close your option positions early. The less time an option has left, the lower its extrinsic value becomes and the more it makes sense for option buyers to exercise their options. Therefore, it is good practice to close your (ITM) short option positions at least one week before the expiration date.
The deeper an option is ITM, the higher the chances of assignment become. So the just-mentioned rule is even more important for deep ITM options.
If you don’t want to indefinitely close your position, it is also possible to roll it out to a later expiration cycle. This will give you more time and add extrinsic value to your position.
Last but not least, I want to answer some frequently asked questions about options exercise and assignment.
This is a common worry for beginning options traders. But don’t worry, if you don’t have enough capital to cover the new position, you will receive a margin call and usually, your broker will just automatically close the assigned shares immediately. This might lead to a minor assignment fee, but otherwise, it won’t significantly affect your account. Tatsyworks, for example, charges an assignment fee of only $5.
Check out my review of tastyworks
When an option is exercised, the option holder gains the difference between the strike price and the price of the underlying asset. If the option is ITM, this is exactly the intrinsic value of the option. This means that the option holder loses the extrinsic value when he exercises his/her option. That’s also why it doesn’t make sense to exercise options with a lot of extrinsic value left.
This means that as soon as the option is exercised, it is only the intrinsic value that is relevant for the payoff. This is the same payoff as the option at its expiration date.
So as an options seller, your P&L isn’t negatively affected by an assignment. Either it stays the same or it becomes slightly better due to the extrinsic value being ignored.
As an example, if your option is ITM by $1, you will lose up to $100 per option or $1 per share that you are assigned. But this does not account for the extrinsic value that falls away with the exercise of the option. So this would be the same P&L as at expiration. Depending on how much premium you collected when selling the option, this might still be a profit or a minor loss.
With that being said, as soon as you are assigned, you will have some carrying risk. If you don’t or can’t close the position immediately, you will be exposed to the ongoing price fluctuations of that security. Sometimes, you might not be able to close the new position immediately because of trading halts, or because the market is closed.
If you weren’t planning on holding that security, it is a good idea to close the new position as soon as possible.
Option spreads such as vertical spreads, add protection to these price fluctuations since you can just exercise the long option to close the assigned share position at the strike price of the long option.
This is usually a random process. As soon as an option is exercised, the responsible brokerage firm sends a request to the Options Clearing Corporation (OCC). They send back the requested shares, whereafter they randomly choose another brokerage firm that currently has a client that is short the exercised option. Then the chosen broker has to decide which of their clients is assigned. This choice is, once again, random or a time-based priority system is used.
As there aren’t any shares of indexes, you can’t directly be assigned any shares of the underlying asset. Therefore, index options are cash-settled. This means that instead of having to buy or sell shares of the underlying, you simply have to pay the difference between the strike price and the underlying trading price. This makes assignment easier and a lot less likely among index options.
Note that ETF options such as SPY options are not cash-settled. SPY is a normal security with openly traded shares, so exercise and assignment work just like they do among equity options.
I hope this article made you realize that assignment isn’t as bad as it might seem at first. It is just important to understand how the options assignment process works and what affects the likelihood of being assigned.
To recap, here’s what you should to do when you are assigned:
if you have enough capital in your account to cover the position, you could either treat the new position as a normal (stock) position and hold on to it or you could close it immediately. If you don’t have a clear trading plan for the new position, I recommend the latter.
If, on the other hand, you don’t have enough buying power, you will receive a margin call from your broker and the position should be closed automatically.
Assignment does not have any significant impact on your P&L, but it comes with some carrying risk. Options spreads can offer more protection against this than naked option positions.
To mitigate assignment risk, you should close option positions early, always keep an eye on the extrinsic value of your option positions, and avoid upcoming dividend securities.
And always remember, less than 10% of options are exercised, so assignment really doesn’t happen that often, especially not if you are actively trying to avoid it.
For the specifics of how assignment is handled, it is a good idea to contact your broker, as the procedures can vary from broker to broker.
Thank you for taking the time and reading this post. If you have any questions, comments, or feedback, please let me know in the comment section below.
hi there well seems like finally there is one good honest place. seem like you are puting on the table the whole truth about bad positions. however my wuestion is when can one know where to put that line of limit. when do you recognise or understand that you are in a bad position? thanks and once again, a great site.
Well If you are trading a risk defined strategy the point would be at max loss and not too much time left until expiration. For undefined risk strategies however it can be very different. I would just say if you don’t have too much time until expiration and are far from making money you should use some common sense and admit that you are wrong.
What would happen in the event of a crash. Would brokers be assigning, options, cashing out these shares, and making others bankrupt. Well, I guessed I sort of answered my own question. Its not easy to understand, especially not knowing when this would come up. But seems like you hit the important aspects of the agreement.
Actually I wouldn’t imagine that too many people would want to exercise their options in case of a market ctash, because they probably wouldn’t want to hold stocks in this risky and volatile environment.
And to the part of the questions: making others bankrupt. This really depends on the situation. You can’t get assigned more stock than your option covers. This means as long as you trade with reasonable position sizing nothing too bad can happen. Otherwise I would recommend to trade with defined risk strategies so your maximum drawdown is capped.
Thanks for writing about assignment Louis. After reading the section how assignment works, I feel I am somewhat unclear about how assignment works when the exerciser exercises Put or Call option. In both cases, if the underlying is an index, is the settlement done through the margin account money? Would you be able to provide a little more detail of how exercising the option (Put vs Call) would work in case of an underlying stock vs Index.
Thank you very much in advance
Thanks for the question. Indexes can’t be traded in the same way as stocks can. That’s why index options are settled in cash. If your index option is assigned, you won’t have to buy or sell any shares of the underlying index at the strike price because there exist no shares of indexes. Instead, you have to pay the amount that your index option is ITM to the exerciser of your option. Let me give you an example: You are short a call option with the strike price of 1000. The underlying asset is an index and it’s price is 1050. This means your call option is 50 points ITM. If someone exercises your long call option, you will have to pay him/her the difference between the strike price and the underlying’s price which would be 50 (1050-1000). So the main difference between index and stock options is that you don’t have to buy/sell any shares of the underlying asset for index options. I hope this helps. Please let me know if you have any other questions or comments.
Can the same logic be applied for ETFs as it does Indexes? For example, if I trade the SPY ETF, would it be settled in cash?
Thanks! Johnson
Hi Johnson, Exercise and assignment for ETFs such as SPY work just like they do for equities. ETFs have shares that are openly traded, whereas indexes don’t. That’s why indexes are settled in cash, whereas ETFs aren’t. I hope this helps.
There are many articles online that I read that are biased against options tradings and I am a bit surprised to read a really helpful article like this. I find this helpful in understanding options trading, what are the techniques and how to manage the risks. Before, I was hesitant to try this financial game but now, after reading this article, I am considering participating with live accounts and no longer with a demo account. A few months ago, I signed up with a company called IQ Options, but really never involved real money and practiced only with a demo account.
Thanks for your comment. I am glad to see that you liked the post. However, I don’t recommend sing IQ Option to trade since they are a very shady trading firm. You could check out my Review of IQ Option for all the details.
this is a great and amazing article. i sincerely your effort creating time to write on such an informative article which has taught me a lot more on what is options assignment and avoiding it. i just started trading but had no ideas on this as a beginner. i find this article very helpful because it has given me more understanding on options trading and knowing the techniques and how to manage the risks. thanks for sharing this amazing article
You are very welcome
Hello, the first thing that i noticed when i opened this page is the beauty of the website. i am sure you have put much effort into creating this article and the details are really clear here. after watching the video break down, i fully understood the entire process on how to avoid options assignment.
Thank you so much for the positive feedback!
I would love to create a website like yours as the design used is really nice, simple and brings about clarity of the write ups, but then you wrote a brilliant article on how to avoid options assignment. great video here. it was confusing at first. i will suggest another video be added to help some people like me.
Thanks for the feedback. I recommend checking out my options trading beginner course . In it, I cover all the basics that weren’t explained here.
Thanks for your very helpful article. I am contemplating selling a call that would cover half my shares on company X. How can ensure that the assignment process selects the shares that I bought at a higher price, so as to maximize capital losses?
Hi Luis, When you are assigned, you just automatically buy/sell shares of the underlying at the strike price. This means your overall portfolio is adjusted by these 100 shares. The exact shares and your entry price are irrelevant. If you have 50 shares of X and your short call is assigned, you will sell 100 shares of X at the strike price. After this, your position would be -50 shares of X which would be equivalent to being short 50 shares of X. I hope this helps.
Louis, I entered a CALL butterfly spread at $100 below where I intended, just 2 days before expiration date. I intended to speculate on a big earning announcement jump the next day. It was a debit of 1.25. Also, when I realized my mistake, I tried to close it for anything at all. The Mark fluctuated between 40 and 70, but I could not get it to close. So now I am assigned to sell 200 share at 70 dollars below the market price of the stock. I am having a heart attack. I do not have the 200 shares to deliver, so it seems I have to buy them at the market, and sell them for $70 less, for a loss of $14,000.
What other options are open to me? Can my trading firm force a close with a friendly market maker and make it as if it happened on Friday? I am willing to pay a friendly market maker several hundred dollars to make this trade. Is that an option? Other options the trading firm can do for me that would cost me less than $14,000?
Hi Paul, Thanks for your comment. From the limited information provided, it is hard to say what is actually going on. If you bought a call butterfly spread, your max loss should be limited to the premium you paid to open the position. An assignment shouldn’t have a huge impact on your overall P&L. I highly recommend contacting your broker and explaining your situation to them since they have all the information required to evaluate what’s actually going on. But if the loss is real, there is no way for you to make a deal with a market maker to limit or undo potential losses. I hope this helps.
What happens with ITM long call option that typically gets automatically exercised at expiration, if the owner of the call option doesn’t have the cash/margin to cover the stock purchase?
He would receive a margin call
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