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Exercising your options
Managing an options trade is quite different from that of a stock trade. Essentially, there are 4 things you can do if you own options: hold them, exercise them, roll the contract, or let them expire. If you sell options, you can also be assigned.
If you are an active investor trading options with some percentage of your overall investment funds, here’s how you can evaluate the available choices for an options trade.
Holding your options
During the life of an options contract you’ve purchased, you can simply hold them (i.e., take no action). Suppose you own call options (which grant the right, but not the obligation, to buy a specified amount of an underlying stock at a specified strike price up and until a specified expiration date) and you believe the underlying stock price will rise within the time remaining until expiration. In this scenario, you would hold the option so that they increase in value over time.
The primary objective of this approach is potential appreciation of the option (based on the underlying stock rising and/or an increase in expected volatility for the underlying stock using our example of buying a call), in addition to delaying additional cost of buying the stock or any tax implications after you exercise the options.
To exercise an option means to take action on the right to buy or sell the underlying position in an options contract at the predetermined strike price, at or before expiration. The order to exercise your options depends on the position you have. For example, if you bought to open call options, you would exercise the same call options by contacting your brokerage company and giving your instructions to exercise the call options (to buy the underlying stock at the strike price).
There are a variety of reasons why you might choose to exercise options before they expire (assuming they are in the money, which means they have value). In addition to wanting to capture realized gains on your options, you may want to exercise:
Be aware that closing out an options position triggers a taxable event, so you would want to consider the tax implications and the timing of closing a trade on your specific situation. You should consult your tax advisor if you have additional questions.
In sum, there are many scenarios that might cause you to want to exercise your options before expiration, and they depend primarily on your outlook for the underlying stock and your objectives/risk constraints.
Employee stock plan options
There are additional choices you can make when exercising employee stock plan options . 1 These include:
- Exercise-and-hold (cash-for-stock)
Rolling your options
Before expiration—and, more commonly, near the end of the contract—you can also choose to roll the contract. This involves closing out your existing options position (by selling to close a long position or buying to close a short position) that is about to expire and simultaneously purchasing a substantially similar options position, only with a later expiration date. You might want to roll out your position if you want to have the same options exposure after your contract is set to expire.
In a covered call position, for example, you can also roll up, roll down, or roll out. This involves closing out your existing short options position that is about to expire, and simultaneously selling another options position, typically with a later expiration date. While there are differences among these choices, the objective is the same: to obtain similar exposure to an existing position.
If you sell an option, you have an obligation to sell stock if you are short a call, and an obligation to buy stock if you are short a put. The owner of call or put options has the right to assign the contract to the seller. This is known as assignment.
Assignment occurs when the buyer exercises an options contract on or before expiration, and the seller must fulfill the obligation by either buying or selling the underlying security at the exercise price. As a seller of options, you can be assigned at any time prior to expiration regardless of the underlying share price—meaning you might have to receive or deliver shares of the underlying stock.
Depending on your position, settlement can occur in a variety of ways. If you are assigned on a covered call, for example, the shares you own will be sold automatically.
Let the options expire
Remember, options have an expiration date. They either have intrinsic value (for calls, the stock is above the strike price, and for puts, the stock is below the strike price) or they will expire worthless. If the options have intrinsic value, you should plan to exercise at or before expiration, or anticipate having it automatically exercised at expiration if in the money. If they do not have intrinsic value, you can simply let your options expire. Of course, letting options expire can also have tax consequences.
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Options Assignment | When Will I Be Assigned Stock?
Feb 21, 2017
By: Mike Butler
Don't let assignment cause you anxiety!
When we talk to our customers, one of their biggest fears when learning how to trade options is getting assigned stock (because remember, when you buy/sell an option, you control 100 shares of that option’s stock). Well, I’m hoping to help you put that anxiety to rest with this post.
Assignment of stock when trading options is just like being given a pop quiz in school - it’s generally unexpected, and usually not a good feeling!
Some people like to be assigned stock as a part of their strategy (i.e. one of the follow traders, Woody, likes to sell puts at a strike price that he is comfortable being assigned stock at, and will always take the assignment when his options are expiring in the money), but this post is more focused on those who do not want to be assigned stock.
The 3 most common questions we get asked related to trading options and being assigned stock are:
What situations would cause me to get assigned stock?
What can I do to prevent being assigned stock?
And…If I am assigned, what should I do?
WHEN WILL I GET ASSIGNED?
Let's tackle the first question that asks...when you invest in options, what scenario would cause you to be assigned shares of stock?
The most common way you will be assigned stock is if you short (sell) an option that expires in the money.
Assignment Risk: Buying An Option
When you buy an option (a call or a put), you cannot be assigned stock unless you choose to exercise your option . Plain and simple, the purchaser of an option contract will always have the choice to exercise the option, but not the obligation to do so.
Let’s say you bought an Apple (ticker symbol AAPL) option a few weeks ago that is set to expire today and the option is in the money (there is never risk of assignment if the option is not in the money), you may do one of two things:
you can let the option expire in the money, which will result in the option being exercised at your strike price and 100 open shares on Monday with a P/L equivalent to the distance between your strike price and the stock price, or...
you can exercise the option and collect 100 shares of the stock
Easy enough to understand, right?
Let’s now break that down even further, by looking at buying calls and buying puts separately to reinforce your understanding.
Assignment When Buying A Naked Call
Remember that if you buy a call, that gives you the right to buy 100 shares of stock at an agreed upon strike price . Let's take a look at an example scenario of getting assigned on a naked call.
As the call buyer, you have the choice whether or not you want to exercise the option. If you exercise your right to purchase shares of the stock (100 shares for each option contract), the seller of the call (let's call him Mike) will automatically have 100 shares called away from his account.
- Bought a FB (Facebook) call option from Mike, at a strike price of $75
- The option is expiring in the money and you decide to exercise the option
- You collect 100 shares of Facebook stock from Mike for $75/share (the strike price)
- Sold a FB (Facebook) call option to you at a strike price of $75
- The option is expiring in the money and you chose to exercise it
- Mike is forced to sell you 100 shares of Facebook stock (even if he doesn’t have the stock in his possession)
If Mike owns the stock already (like in a covered call position), his stock will be called away. If he does not own the stock, he will now be assigned -100 shares of stock per option contract. If Mike does not have enough buying power to short the stock, he will be forced to close the position immediately by his broker and will be charged an assignment fee (on top of regular commission rates).
The proper term for being assigned negative shares of stock is called being ’short stock’. Think about it like this. When you buy stock, you are taking a bullish position because the only way you profit from stock ownership, is if the stock goes up. But what if you wanted to take the opposite side of the bet by just investing in stock (a bearish position)? You would short the stock and own negative shares.
Assignment When Buying A Naked Put
If you purchase a put option, remember that that gives you the right (but not the obligation) to sell shares of stock at an agreed upon strike price. This means that if the put option expires in the money, the put seller has the obligation to purchase the stock at the same strike price. Let's again reference our example in which you are buying an option from Mike.
As the put buyer, if you exercise your right to sell stock, then Mike will automatically be sold 100 shares of stock per option contract. If the new stock is something Mike wants to keep, he certainly can if he has the available funds in his account. If he chooses to do so, he will now own 100 shares/contract at the strike price.
- Bought a FB (Facebook) put option from Mike, at a strike price of $72
- You sell 100 shares of Facebook stock to Mike for $72/share (the strike price)
- Sold a FB (Facebook) put option to you at a strike price of $72
- The option is expiring in the money and you chose to exercise it.
- Mike must purchase 100 shares of Facebook stock from you (even if he doesn’t have enough money in his account)
If Mike does not have enough capital to buy the stock, he will still own the stock temporarily, but will be forced to close the position immediately (this is usually a margin call from your broker) and he will be charged an assignment fee (in addition to the regular commission fees).
ASSIGNMENT WHEN BUYING A CALL/PUT SPREAD
Example of a long call spread - notice the green long call is in the money.
Remember that a vertical spread is made up of buying one option and selling the same type of option (both options would be calls or puts).
Vertical spreads offer more protection than naked options when it comes to assignment. This isn’t to say there is less risk involved in actually getting assigned, but you have more tools to mitigate being long or short stock.
When buying a call spread or put spread, the risk of assignment is determined by how much of the spread is in the money. If both legs are in the money at expiration , you could still be assigned, but since your other leg is in the money, you can exercise that to collect max profit. If only one strike is in the money (the short strike - aka the option that you sold), that is where you run the risk of assignment.
When you’re the option buyer, you have the power over assignment . If you are the option seller, that is a different story...
Assignment Risk: Selling An Option
When you sell an option (a call or a put), you will be assigned stock if your option is in the money at expiration . As the option seller, you have no control over assignment, and it is impossible to know exactly when this could happen. Generally, assignment risk becomes greater closer to expiration. With that said, assignment can still happen at any time.
Let’s say you sold a GOOG (ticker symbol for Google) option a couple weeks ago that is set to expire today and the option is in the money. In this scenario, you will automatically be assigned 100 shares of stock (if you sold a call then you would be assigned -100 shares of stock and if you sold a put, you would be assigned 100 shares of stock).
ASSIGNMENT WHEN Selling A NAKED CALL
Unlike when you are the buyer of a naked call, when you're the seller of a naked call option, you do not have control over assignment if your call expires in the money (it only has to be $.01 in the money). In this scenario, you will automatically be forced to sell 100 shares of stock to the purchaser of the option.
Let's go back to the example with you and Mike. If you sell a GOOG call option to Mike at a strike price of $525 and Mike decides to exercise (because the option is in the money), you have to sell him 100 GOOG shares per option contract for $525/share. Even if you do not have GOOG stock you will still have to sell Mike the shares (in which case you will be short 100 shares of GOOG stock).
- Bought a GOOG (Google) call option from you, at a strike price of $550
- The option is expiring in the money and Mike decides to exercise the option
- Mike collects 100 shares of Google stock from you for $550/share (the strike price)
- Sold a GOOG (Google) call option to Mike at a strike price of $550
- The option is expiring in the money and Mike chooses to exercise it
- You must sell Mike 100 shares of Google stock (even if you don’t have the stock in your possession)
Don't forget, if you do not close the trade or roll it before expiration and do have to sell the shares, you will also be charged an assignment fee and regular commission fees.
*One Important Note: there is additional assignment risk when a company has upcoming dividends (dividends are when a company distributes cash to shareholders). Essentially, if the extrinsic value on an ITM short call is LESS than the dividend amount, the ITM call owner will have good reason to exercise their option so that they can realize the dividend associated with owning the stock.
ASSIGNMENT WHEN SELLING A NAKED PUT
Similar to selling a naked call, when you sell a naked put, you again do not have control over assignment if your option expires in the money at expiration. If your short put expires in the money at expiration, you will be assigned 100 shares of stock at the option's strike price and charged an assignment fee plus commissions.
Last time with the example, I swear (from my experience, repetition is key to understanding options): if you sell Mike a naked put that is expiring in the money and Mike chooses to exercise those shares, you will have to buy 100 shares of GOOG stock per option contract, at $525/share. And again, you will be charged an assignment fee and commission fees.
- Bought a GOOG (Google) Put Option from you at a strike price of $525
- The option is expiring in the money and you Mike chooses to exercise it. You must buy 100 shares of GOOG stock from Mike (even if you don't have enough money in your account)
- Sold a GOOG (Google) put option to Mike at a strike price of $525
- You must purchase 100 shares of Google stock from Mike (even if you don’t have enough money in your account)
ASSIGNMENT WHEN SELLING A Call/Put Spread
Example of a short call spread - notice the red short call in the money.
When you sell a put spread or call spread, the assignment risk comes from your short strike expiring in the money (just like when you buy a call/put spread). If both strikes expire in the money, they will essentially cancel each other out and you will not be assigned (you will be assigned on the short strike, and then you can excercise your long strike).
If you sell a call spread and the short strike is in the money at expiration, you will be forced to sell 100 shares per option contract to the buyer. If you sell a put spread and just the short strike is in the money at expiration, you will be assigned 100 shares of stock per contract.
How can you avoid being assigned before it happens? There are two ways:
You can close the trade before it expires and take any profit or loss on the trade
You can roll the trade to extend the days to expiration, giving you more time to be right
When it comes to assignment, we totally understand the fear investors have. That's why the tastytrade trading platform was designed with a feature that can help prevent you from being assigned with a quick glance. Whenever you sell an option that is in the money, or has moved in the money, there is an 'ITM' symbol that will show up on your portfolio page.
Despite our best efforts to avoid unwanted assignment, it can still happen from time to time. This leaves new investors wondering what to do if this scenario occurs...
What Happens If I am assigned?
I imagine I looked a little like this when I realized I had been assigned.
Assignment can happen pretty easily if you are not monitoring you positions on a regular basis (and can happen even if you are).
Just last week, I had an ITM option expire on a day where I was wrapped up in meetings and projects, and ended up being assigned stock. If you get busy during the day or if you are trading an illiquid underlying (in which case there may not be any buyers/sellers available so you cannot close the position), this can happen to you.
We mentioned the following scenarios before, but wanted to hammer the points home in the event that you are assigned. There are two things that can happen if you sold an option that has expired in the money...
If you were assigned stock and had the money to cover the shares in your account, then you can choose to hold the long (or short) stock, or buy/sell the shares back for a profit or loss.
If you were assigned shares and don't have the money to cover the shares you were assigned (the term for this is a margin call), you will need to buy/sell back the shares ASAP. If you do not, the broker will do it for you before the end of the trading day.
There's a lot of information in this post, so let's recap the most important takeaways:
Assignment can happen at any time - it is contolled by the option buyer.
If you do not have enough funds in your account to cover long or short stock, you should close the position immediately (or your broker will do it for you).
Spreads give more protection against being assigned, but they do not protect you unless BOTH legs are in the money.
If you have a short call position, there is additional assignment risk if that call is in the money at the time of the dividend.
If you ever have any questions about assignment, don't hesitate to reach out to our support team at [email protected] !
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
Earnings & options | learn how to trade earnings.
Sep 7, 2017
Most investors are familiar with what earnings are, but less know about the different strategies and considerations when investing in a company with upcoming earnings. In this post you will learn about what earnings are, the terminology associated with earnings, and how you can place an 'earnings trade.'
Delta | What It Tells You About Your Position & Portfolio
Aug 30, 2017
Instead of going through different positions and strategies to figure out which way you need the market to go to make money, delta will give you a snapshot of this information for each position, strategy, and even your overall portfolio. On the simplest level, delta (positive or negative) tells us which way we want the underlying to go to make money.
What is Strike Price? Definition, Examples & Considerations
Jul 7, 2017
Strike price is an important options trading concept to understand. This post will teach you about strike prices and help you determine how to choose the best one.
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The Risks of Options Assignment
Any trader holding a short option position should understand the risks of early assignment. An early assignment occurs when a trader is forced to buy or sell stock when the short option is exercised by the long option holder. Understanding how assignment works can help a trader take steps to reduce their potential losses.
Understanding the basics of assignment
An option gives the owner the right but not the obligation to buy or sell stock at a set price. An assignment forces the short options seller to take action. Here are the main actions that can result from an assignment notice:
- Short call assignment: The option seller must sell shares of the underlying stock at the strike price.
- Short put assignment: The option seller must buy shares of the underlying stock at the strike price.
For traders with long options positions, it's possible to choose to exercise the option, buying or selling according to the contract before it expires. With a long call exercise, shares of the underlying stock are bought at the strike price while a long put exercise results in selling shares of the underlying stock at the strike price.
When a trader might get assigned
There are two components to the price of an option: intrinsic 1 and extrinsic 2 value. In the case of exercising an in-the-money 3 (ITM) long call, a trader would buy the stock at the strike price, which is lower than its prevailing price. In the case of a long put that isn't being used as a hedge for a long stock position, the trader shorts the stock for a price higher than its prevailing price. A trader only captures an ITM option's intrinsic value if they sell the stock (after exercising a long call) or buy the stock (after exercising a long put) immediately upon exercise.
Without taking these actions, a trader takes on the risks associated with holding a long or short stock position. The question of whether a short option might be assigned depends on if there's a perceived benefit to a trader exercising a long option that another trader has short. One way to attempt to gauge if an option could be potentially assigned is to consider the associated dividend. An options seller might be more likely to get assigned on a short call for an upcoming ex-dividend if its time value is less than the dividend. It's more likely to get assigned holding a short put if the time value has mostly decayed or if the put is deep ITM and close to expiration with a wide bid/ask spread on the stock.
It's possible to view this information on the Trade page of the thinkorswim ® trading platform. Review past dividends, the price of the short call, and the price of the put at the call's strike price. While past performance cannot be relied upon to continue, this information can help a trader determine whether assignment is more or less likely.
Reducing the risk associated with assignment
If a trader has a covered call that's ITM and it's assigned, the trader will deliver the long stock out of their account to cover the assignment.
A trader with a call vertical spread 4 where both options are ITM and the ex-dividend date is approaching may want to exercise the long option component before the ex-dividend date to have long stock to deliver against the potential assignment of the short call. The trader could also close the ITM call vertical spread before the ex-dividend date. It might be cheaper to pay the fees to close the trade.
Another scenario is a call vertical spread where the ITM option is short and the out-of-the-money (OTM) option is long. In this case, the trader may consider closing the position or rolling it to a further expiration before the ex-dividend date. This move can possibly help the trader avoid having short stock on the ex-dividend date and being liable for the dividend.
Depending on the situation, a trader long an ITM call might decide it's better to close the trade ahead of the ex-dividend date. On the ex-dividend date, the price of the stock drops by the amount of the dividend. The drop in the stock price offsets what a trader would've earned on the dividend and there would still be fees on top of the price of the put.
Assess the risk
When an option is converted to stock through exercise or assignment, the position's risk profile changes. This change could increase the margin requirements, or subject a trader to a margin call, 5 or both. This can happen at or before expiration during early assignment. The exercise of a long option position can be more likely to trigger a margin call since naked short option trades typically carry substantial margin requirements.
Even with early exercise, a trader can still be assigned on a short option any time prior to the option's expiration.
1 The intrinsic value of an options contract is determined based on whether it's in the money if it were to be exercised immediately. It is a measure of the strike price as compared to the underlying security's market price. For a call option, the strike price should be lower than the underlying's market price to have intrinsic value. For a put option the strike price should be higher than underlying's market price to have intrinsic value.
2 The extrinsic value of an options contract is determined by factors other than the price of the underlying security, such as the dividend rate of the underlying, time remaining on the contract, and the volatility of the underlying. Sometimes it's referred to as the time value or premium value.
3 Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.
4 The simultaneous purchase of one call option and sale of another call option at a different strike price, in the same underlying, in the same expiration month.
5 A margin call is issued when the 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 buying power is exceeded. Margin calls may be met by depositing funds, selling stock, or depositing securities. A broker may forcibly liquidate all or part of the account without prior notice, regardless of intent to satisfy a margin call, in the interests of both parties.
Just getting started with options?
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Today's Options Market Update
Weekly Trader's Outlook
Ex-Dividend Dates: Understanding Dividend Risk
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.
Spread trading must be done in a margin account.
Multiple leg options strategies will involve multiple commissions.
Commissions, taxes and transaction costs are not included in this discussion, but can affect final outcome 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.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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What Is an Option Assignment?
Definition and Examples of Assignment
How does assignment work, what it means for individual investors.
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An option assignment represents the seller of an option’s obligation to fulfill the terms of the contract by either selling or purchasing the underlying security at the exercise price. Let’s explain what that means in more detail.
- An assignment represents the seller of an option’s obligation to fulfill the terms of the contract by either selling or purchasing the underlying security at the exercise price.
- If you sell an option and get assigned, you have to fulfill the transaction outlined in the option.
- You can only get assigned if you sell options, not if you buy them.
- Assignment is relatively rare, with only 7% of options ultimately getting assigned.
An assignment represents the seller of an option’s obligation to fulfill the terms of the contract by either selling or purchasing the underlying security at the exercise price. Let’s explain what that means in more detail.
When you sell an option to someone, you’re selling them the right to make you engage in a future transaction. For example, if you sell someone a put option , you’re promising to buy a stock at a set price any time between when the transaction happens and the expiration date of the option.
If the holder of the option doesn’t do anything with the option by the expiration date, the option expires. However, if they decide that they want to go through with the transaction, they will exercise the option.
If the holder of an option chooses to exercise it, the seller will receive a notification, called an assignment, letting them know that the option holder is exercising their right to complete the transaction. The seller is legally obligated to fulfill the terms of the options contract.
For example, if you sell a call option on XYZ with a strike price of $40 and the buyer chooses to exercise the option, you’ll be assigned the obligation to fulfill that contract. You’ll have to buy 100 shares of XYZ at whatever the market price is, or take the shares from your own portfolio and sell them to the option holder for $40 each.
Options traders only have to worry about assignment if they sell options contracts. Those who buy options don’t have to worry about assignment because in this case, they have the power to exercise a contract, or choose not to.
The options market is huge, in that options are traded on large exchanges and you likely do not know who you’re buying contracts from or selling them to. It’s not like you sell an option to someone you know and they send you an email if they choose to exercise the contract, rather it is an organized process.
In the U.S., the Options Clearing Corporation (OCC), which is considered the options industry clearinghouse, helps to facilitate the exchange of options contracts. It guarantees a fair process of option assignments, ensuring that the obligations in the contract are fulfilled.
When an investor chooses to exercise a contract, the OCC randomly assigns the obligation to someone who sold the option being exercised. For example, if 100 people sold XYZ calls with a strike of $40, and one of those options gets exercised, the OCC will randomly assign that obligation to one of the 100 sellers.
In general, assignments are uncommon. About 7% of options get exercised, with the remaining 93% expiring. Assignment also tends to grow more common as the expiration date nears.
If you are assigned the obligation to fulfill an options contract you sold, it means you have to accept the related loss and fulfill the contract. Usually, your broker will handle the transaction on your behalf automatically.
If you’re an individual investor, you only have to worry about assignment if you’re involved in selling options. Even then, assignments aren't incredibly common. Less than 7% of options get assigned and they tend to get assigned as the option’s expiration date gets closer.
Having an option assigned does mean that you are forced to lock in a loss on an option, which can hurt. However, if you’re truly worried about assignment, you can plan to close your position at some point before the expiration date or use options strategies that don’t involve selling options that could get exercised.
The Options Industry Council. " Options Assignment FAQ: How Can I Tell When I Will Be Assigned? " Accessed Oct. 18, 2021.
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Options Basics: How the Option Assignment Process Works
July 23, 2021 — 12:46 pm EDT
Written by [email protected] for Schaeffer ->
There is a lot of technical jargon that is specific to the options market. For a beginner who is aiming to learn how to trade options, understanding these technical terms is crucial to optimizing trading results. One phrase that is a critical part of this options trading language is “assignment.” Simply defined, the assignment of an option refers to the fulfillment of the options contract by the seller. An option holder has the right to buy or sell the underlying equity at the given strike price. Once the holder decides to exercise the option, the option is said to be “assigned.” If a trader sells options, he must be aware of the assignment process and the risks it entails. We recommend subscribing to one of Schaeffer's options trading newsletters to gain the ultimate insights into the language of the options market while making money, too.
What Does it Mean to Write an Option?
When an options seller writes an options contract, this is known as a “sell to open” trade, as he is essentially opening a new position. As the trader is selling the option to open this position, he is technically said to be “short” that underlying stock. The seller accepts a responsibility to sell or buy the underlying security in lieu of a premium received from the buyer. As a general rule, an option holder can exercise his rights any time before the contract expires. In order to learn to trade options, it is necessary to grasp this structure of corresponding rights and duties. It's important to also note that most options are exercised when they are nearing expiry because, after that, the options contract is worthless.
How Does the Option Assignment Process Work?
The assignment process is done at random by the Options Clearing Corporation (OCC) . A trader will become more acquainted with the operations of the OCC as he or she learns to trade options. When a buyer exercises his option, the OCC will randomly connect them with a brokerage that is short on options of that equity. Due to the lottery-like nature of the process, it is almost impossible to predict when an investor’s option may be assigned.
2 Categories of Options to Understand
As a brief summary, let’s go over the two basic categories of options. These categories and their respective merits become apparent as one learns to trade options. In a call option, the option holder possesses the right to buy the security before the contract expires. In this scenario, the seller’s obligation is to sell the option upon assignment.
The inverse of this is the put option. In this category, the holder has the right to sell to the security at the contract price. The consequence of this is that upon assignment, the seller must purchase the security at the strike price. If an investor does not own the stock, he must first buy it. After this, he must deliver it to the holder.
Initially, a seller has an edge in the options trading process. He starts with a net benefit as a premium is paid to him by the buyer without him giving any monetary return immediately. If an option is never exercised, the seller actually retains the premium if the contract expires.
However, the issues arise as the contract nears its expiry, as the chances of assignment increase exponentially. The problem for investors when called to assign are three-fold: 1) they have no control over when the option is exercised, 2) they must fulfill their end of the bargain irrespective of whether this could lead to a loss or a low gain, and 3) even if the underlying stock is not trading, in a call option the deliver the stock to the buyer.
Can an Options Seller Predict When an Option Will Be Exercised?
It would be misleading if we were say there is some magic formula that we could use to predict when an option will be exercised. Traders will understand how frequent assignment occurs once they more completely learn to trade options. However, a general statistic is that approximately 7% of options are actually ever exercised. Even though, technically, an option can be assigned any time while the contract remains open, option holders usually exercise their option near its expiration date. This is because traders usually wait to find the ideal time and observe trading prices. As you learn to trade options, you will realize that very few buyers ever exercise options ahead of expiration.
When is Options Assignment Less Likely?
Even though we cannot accurately predict when an option will be exercised, there are certain indicators traders can use. These indicators are easier to see when you learn to trade options and observe market trends.
An assignment is less probable when an option is out-of-the-money. An option is out-of-the-money when the security is trading at a higher value in the market as compared to the strike price. It is rarely recommended to sell an option that is out-of-the-money. This is because if the strike price is lower than the market value, the option holder will make a loss on the contract. If the strike price is $30, and the market value is $20 and the holder exercises the call option, they will end up taking a loss since they are buying it at a higher price. As investors learn to trade options, they can better predict the time of assignment with greater accuracy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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Understanding assignment risk in Level 3 and 4 options strategies
E*TRADE from Morgan Stanley
With all options strategies that contain a short option position, an investor or trader needs to keep in mind the consequences of having that option assigned , either at expiration or early (i.e., prior to expiration). Remember that, in principle, with American-style options a short position can be assigned to you at any time. On this page, we’ll run through the results and possible responses for various scenarios where a trader may be left with a short position following an assignment.
Before we look at specifics, here’s an important note about risk related to out-of-the-money options: Normally, you would not receive an assignment on an option that expires out of the money. However, even if a short position appears to be out of the money, it might still be assigned to you if the stock were to move against you just prior to expiration or in extended aftermarket or weekend trading hours. The only way to eliminate this risk is to buy-to-close the short option.
- Short (naked) calls
Credit call spreads
Credit put spreads, debit call spreads, debit put spreads.
- When all legs are in-the-money or all are out-of-the-money at expiration
Another important note : In any case where you close out an options position, the standard contract fee (commission) will be charged unless the trade qualifies for the E*TRADE Dime Buyback Program . There is no contract fee or commission when an option is assigned to you.
Short (naked) call
If you experience an early assignment.
An early assignment is most likely to happen if the call option is deep in the money and the stock’s ex-dividend date is close to the option expiration date.
If your account does not hold the shares needed to cover the obligation, an early assignment would create a short stock position in your account. This may incur borrowing fees and make you responsible for any dividend payments.
Also note that if you hold a short call on a stock that has a dividend payment coming in the near future, you may be responsible for paying the dividend even if you close the position before it expires.
An early assignment generally happens when the put option is deep in the money and the underlying stock does not have an ex-dividend date between the current time and the expiration of the option.
Short call + long call
(The same principles apply to both two-leg and four-leg strategies)
This would leave your account short the shares you’ve been assigned, but the risk of the position would not change . The long call still functions to cover the short share position. Typically, you would buy shares to cover the short and simultaneously sell the long leg of the spread.
Pay attention to short in-the-money call legs on the day prior to the stock’s ex-dividend date, because an assignment that evening would put you in a short stock position where you are responsible for paying the dividend. If there’s a risk of early assignment, consider closing the spread.
Short put + long put
Early assignment would leave your account long the shares you’ve been assigned. If your account does not have enough buying power to purchase the shares when they are assigned, this may create a Fed call in your account.
However, the long put still functions to cover the position because it gives you the right to sell shares at the long put strike price. Typically, you would sell the shares in the market and close out the long put simultaneously.
Here's a call example
- Let’s say that you’re short a 100 call and long a 110 call on XYZ stock; both legs are in-the-money.
- You receive an assignment notification on your short 100 call, meaning you sell 100 shares of XYZ stock at 100. Now, you have $10,000 in short stock proceeds, your account is short 100 shares of stock, and you still hold the long 110 call.
- Exercise your long 110 call, which would cover the short stock position in your account.
- Or, buy 100 shares of XYZ stock (to cover your short stock position) and sell to close the long 110 call.
Here's a put example:
- Let’s say that you’re short a 105 put and long a 95 put on XYZ stock; the short leg is in-the-money.
- You receive an assignment notification on your short 105 put, meaning you buy 100 shares of XYZ stock at 105. Now, your account has been debited $10,500 for the stock purchase, you hold 100 shares of stock, and you still hold the long 95 put.
- The debit in your account may be subject to margin charges or even a Fed call, but your risk profile has not changed.
- You can sell to close 100 shares of stock and sell to close the long 95 put.
Long call + short call
Debit spreads have the same early assignment risk as credit spreads only if the short leg is in-the-money.
An early assignment would leave your account short the shares you’ve been assigned, but the risk of the position would not change . The long call still functions to cover the short share position. Typically, you would buy shares to cover the short share position and simultaneously sell the remaining long leg of the spread.
Long put + short put
An early assignment would leave your account long the shares you’ve been assigned. If your account does not have enough buying power to purchase the shares when they are assigned, this may create a Fed call in your account.
All spreads that have a short leg
(when all legs are in-the-money or all are out-of-the-money)
Pay attention to short in-the-money call legs on the day prior to the stock’s ex-dividend date because an assignment that evening would put you in a short stock position where you are responsible for paying the dividend. If there’s a risk of early assignment, consider closing the spread.
However, the long put still functions to cover the long stock position because it gives you the right to sell shares at the long put strike price. Typically, you would sell the shares in the market and close out the long put simultaneously.
What to read next...
How to buy call options, how to buy put options, potentially protect a stock position against a market drop, looking to expand your financial knowledge.
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The assignment risks of writing call and puts – covered or not.
Dec 22, 2020
Writing options, which is also called selling options, alone or as part of a covered strategy, has unlimited risk potential in your account when writing a call option, and the maximum risk for writing a put is if the stock price goes to zero, which could cause a significant loss. As the writer of an option, you have certain obligations you must fulfill, and these obligations are out of your control while you maintain an open short options position.
When you write a call option, you take on the obligation to deliver long stock to the call buyer at the contract strike from the time of sale until the expiration date. For this obligation, you collect an option premium from the buyer at the current option price (less costs of the trade), which is your maximum gain on this position. The maximum risk here is unlimited, the stock can go to the moon, and you are on the hook for the entire journey.
When you write a put option, you take on the obligation to deliver short stock to the put buyer at the contract strike at any time from the time of sale until the expiration date. For this obligation, you collect an option premium from the buyer at the current option price (less the costs of the trade), which is your maximum gain on this position. The maximum risk here is unlimited for writing a call option, and when writing a put option the risk is limited to the stock going to zero, but this floor can still result in a significant loss.
Benefits of Writing Call and Put Options
Generally, writing options have two main benefits and purposes: (1) to capture the option premium time value as the option decays on the way to expiration; and (2) to reduce the cost of putting on a directional long call or put trade. Writing calls and puts and buying calls and puts in combinations allow you to trade many different market outlooks – bullish, bearish, low volatility, high volatility, and others.
The Risks of Writing Call and Put Options
First, most brokers require that you have some options trading experience before your account is approved to write options, and you will also be required to maintain a minimum account balance. You should always make sure that you have enough money to cover the initial margin and should consider an additional cushion amount for a reasonable move against the position and to deliver the stock position if assigned. Always check with your broker regarding minimum capital requirements.
Second, there is assignment risk throughout the life of the trade for American-style options. Typically, options are assigned only when they are deep in-the-money, or when there is an advantage to exercising to capture a stock dividend (see “Dividend Considerations” below). Still, an option writer can be assigned anytime up until expiration.
Finally, writing options generally requires a margin account, but you can also write a cash-secured put in a cash account that covers the full value of the options position.
You can never really tell when you will be assigned. Once you write an American-style option (put or call), you have the potential for assignment, to receive (and pay for) or deliver (and are paid for) shares of stock. In some circumstances, you may be assigned on a short options position while the underlying shares are halted for trading, or perhaps while they are the underlying company is the subject of a buyout or takeover.
To ensure fairness in the distribution of option assignments, the Options Clearing Corporation (OCC) utilizes a random procedure to assign exercise notices to clearing member accounts maintained with the OCC. The assigned firm must then use an exchange-approved method (usually a random process or the first-in, first-out method) to allocate notices to its clients’ accounts that are short the options.
An option buyer holding a call or put has the right to exercise that option at any time to take delivery of the long (Call) or short stock (Put). The option writer is always at risk of early assignment at any time through expiration for American-style options.
There are several types of assignment risk factors you should understand:
- In-the-money early exercise a. Dividend considerations
- Exercise at expiration a. After-hours trading b. “Do not exercise”
In-The-Money Early Exercise
The chance of early assignment happens most often when the options are in-the-money (ITM), and although it is unlikely, even an option that is out-of-the-money (OTM), under certain circumstances, could be assigned at expiration.
Credit Spread early assignment example – in-the-money exercise XYZ stock is currently trading at $80 per share. Two weeks ago, you put on a credit spread when XYZ was trading at $92 per share. You wrote 1 95 put for $5 and bought 1 90 put $2.50 for a credit of $2.50, or $250. Both options are now in-the-money, and the 95 put you wrote is assigned to you, and to offset that assignment, you exercise your 90 Put. You are flat, out of the position, but also incur a number of fees and may have some price risk before all is said and done.
If you are writing a call option in a spread on a stock that pays a dividend, there is additional assignment risk if the call option is in-the-money and/or has less extrinsic (time value) than the dividend payout.
This is a good time to remind you that there can be a lot of moving pieces in an options trade. You should be aware of several factors if you are writing call options on a stock that pays a dividend including: the amount of the dividend, the ex-dividend date, and the impact the upcoming dividend payment may have on the price of the stock and the option premium.
If you are assigned short stock just prior to ex-dividend date, you will be responsible for paying the dividend. So, it may not be worth the trouble here. You may want to close or roll forward any short in-the-money call positions well in advance of any ex-dividend date.
Exercise at Expiration
At expiration, the buyer of an option is in control and can exercise at any time prior to the cutoff time on Friday expiration. If you hold short options, calls, or puts, into and through expiration, bad things could happen that are out of your control even if those options are out-of-the-money.
Keep in mind that most stock options stop trading at 4:00 pm ET when the regular stock market session closes, but many stocks continue to trade after hours until 8:00 pm ET, even on expiration Friday, which may affect the intrinsic value and possibly the decision of a call or put option buyer to exercise an option, as exercise can take place hours after the market has closed on expiration Friday.
Credit Spread after-hours assignment example at expiration – out-of-the-money exercise It is expiration Friday, and the markets just closed. XYZ stock is currently trading at $96 per share. Two weeks ago, you put on a credit spread when XYZ was trading at $92 per share. You wrote 1 95 put for $5 and bought 1 90 put for $2.50, for a credit of $2.50, or $250. Both options expire out-of-the-money worthless, and you expect to collect your $250 profit. However, for some unknown reason, the buyer of a 95 put exercises, and you are selected and assigned the long stock. Your covering 90 put option has expired, leaving your new long stock exposed to the market, and over the weekend, the CEO of XYZ is arrested for embezzlement, and XYZ opens Monday at $50.00 per share, creating an unrealized loss in your account of $4,000 on that 1-contract position.
Do Not Exercise (DNE)
An option buyer may give his broker the instructions to “Do Not Exercise” at expiration regardless of the in-the-money value of the option. Why would someone just give away that money? Typically, this can happen when an option is slightly out-of-the-money at the close of the session on the expiration date, and there is a chance the option value will rise in the aftermarket session. Often, “Do Not Exercise“ instructions are given to the broker if the option buyer does not have enough money in their account to take delivery of the exercised stock.
“Do Not Exercise“ can be a problem for an option writer as the contract is voided. The voided contract is assigned to a random option seller of that contract.
Credit Spread assignment example at expiration – in-the-money – do not exercise It is expiration Friday, and the markets just closed. XYZ stock is currently trading at $89.00 per share. Two weeks ago, you put on a credit spread when XYZ was trading at $92 per share. You wrote 1 95 put for $5 and bought 1 90 put for $2.50, for a credit of $2.50, or $250. Both options are now in-the-money, and you expect to lose $250 on the trade. However, a put buyer somewhere does not have enough money in his account to exercise their put option, so before the 5:30 pm deadline on expiration day, he informs his broker – “Do Not Exercise”; this will cause him to lose the $600 ($6 per share $95-$89). The OCC designates an options writer to offset this non-exercised put, and that contract is voided. However, you were counting on that short 95 put contract to offset your long 90 put, but there is now no short put any longer in your account, and you are auto-exercised on the long 90 put and must short the 100 shares of XYZ stock, and you are now exposed to the XYZ price action open on Monday.
Will I Get Assigned?
You can never really tell when you will be assigned. Once you write an American-style option (put or call), you have the potential for assignment, to receive (and pay for) or deliver (and are paid for) shares of stock. In some circumstances, you may be assigned on a short option position while the underlying shares are halted for trading, or perhaps while they are the subjects of a buyout or takeover.
To ensure fairness in the distribution of option assignments, the Options Clearing Corporation (OCC) utilizes a random procedure to assign exercise notices to clearing member accounts maintained with OCC. The assigned firm must then use an exchange-approved method (usually a random process or the first-in, first-out method) to allocate notices to its client’s accounts that are short the options.
Writing calls and puts even as part of a limited risk type spread can be high-risk strategies going into expiration and are not appropriate for every trader or every account.
And although the strategy of writing options is often to have the options expire worthless, you need to stay keenly aware of all the circumstances that can affect your position as it approaches expiration. There are a lot of moving pieces here, and you need to be aware of all of them.
So, based on all of the factors and risks, there may be times when closing a short options position prior to expiration, to avoid and assignment risk, may be the right call. It may cost you some profits, but it will reduce your stress and eliminate any further risk and the chance of an unexpected loss.
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How Option Assignment Works: Understanding Options Assignment
A breakdown of options assignment for active traders.
Options assignment is a process in options trading that involves fulfilling the obligations of an options contract.
It occurs when the buyer of an options contract exercises their right to buy or sell the underlying asset. The seller (writer) of the options contract must deliver or receive the underlying asset at the agreed-upon price (strike price).
What is Options Assignment?
Options assignment can happen when the owner of an option exercises their right to buy or sell shares of stock or when options expire in the money (ITM). This process can be complex and involves various factors such as the type of option, expiration date, and market conditions.
There are two main styles of options contracts: American-style and European-style. American-style options allow the buyer of a contract to exercise at any time during the life of the contract. In contrast, European-style options can only be exercised on the expiration date.
Traders selling American-style options are at risk of assignment anytime on or before the expiration date. While they can technically be assigned anytime, the option must be ITM for the owner of the contract to benefit from exercising their right.
On the other hand, many options traders prefer to sell European-style options as it is impossible to be assigned before the expiration date, giving them more flexibility to hold their contract without worrying about being assigned early.
Who is at Risk of Assignment in Options Trading?
Traders with short options positions are at risk of assignment because they have sold the option and are obligated to deliver or receive the underlying asset. If the owner of the options contract decides to exercise their rights, the seller of the options contract must fulfill their obligations.
Traders with long options positions are not at risk of assignment as they are in control of exercising their options. A long option holder has the right, but not the obligation, to buy or sell the underlying asset at the strike price. If the long option holder decides not to exercise their options, they can let the options contract expire worthless.
What is the Risk of Assignment?
The risks associated with options assignment are primarily centered around the obligations of the seller of the options contract. If the holder of the options contract decides to exercise their right to buy or sell the underlying asset, the seller must fulfill their obligations.
For example, if a trader sold a put option with a $100 strike price, and the stock dropped to $90, they would still have to buy the stock at $100 per share. When an option is ITM, it generally indicates that the seller of the option is in an unfavorable spot.
Of course, if you sold a $100 strike put option when the stock was trading at $120, and now it is trading at $90, the seller is likely regretting their original trade. However, it is impossible always to time the market perfectly, and assignment risk is the risk option sellers must assume.
Traders must be aware of market conditions that could increase the risk of assignment, such as large price movements in the underlying asset. Option selling strategies benefit from a stable market environment, so you must ensure the stock you are trading will remain stable until the expiration date. Events that may cause significant market volatility, such as earnings, are crucial to be aware of when selling options.
How to Avoid Option Assignment
While it may not be possible to avoid options assignment completely, there are several strategies that options traders can use to reduce the likelihood of being assigned.
One strategy is to manage short options positions by closing the position if your strike gets tested. For example, if you sold a $100 strike put when a stock is trading at $120 per share, you can avoid assignment by closing the position before the stock drops under your strike price of $100.
Another strategy is to roll over your option, which means you close it out and simultaneously sell a new contract with a different strike price and/or date. Traders can roll their contracts to the same strike price at a further date or even roll it down or up to ensure their contract stays out of the money (OTM).
These strategies may not always be effective in avoiding assignment. Traders should always be prepared to fulfill their obligations if they are assigned and have a plan to manage their positions accordingly. If a stock moves hard overnight, there is no guarantee you will successfully avoid assignment.
Do You Keep the Premium if You Get Assigned?
Yes, if you get assigned on a short options position, you still keep the premium you received initially. However, it is important to note that if you are assigned, you will also be obligated to fulfill the contract terms by buying or selling the underlying asset at the strike price. This means you may incur additional costs associated with fulfilling your obligation, such as purchasing the underlying asset at an unfavorable price.
What Happens When Your Covered Call Gets Assigned?
If a covered call gets assigned, the seller of the call option must sell the underlying stock at the strike price to the buyer of the call option. The seller will still be able to keep the premium received from the sale of the call option.
For example, if you own a stock at $100 per share and sell a $130 strike call option, you will be forced to sell if the stock is above $130 on the expiration date. Additionally, you can be assigned before the expiration date if the stock is trading above your strike price.
While the covered call seller will still generate a profit from this trade, the downside is you are likely missing out on more upside potential had you not sold the covered call. The seller of the covered call doesn’t have to do anything, as the broker will take care of the assignment for you.
Are Options Automatically Assigned?
If you are an option seller, your option will either be exercised by the buyer or automatically assigned if it is ITM on the expiration date.
If you are an option buyer, your option will not be automatically assigned before expiration. However, most brokers will automatically assign ITM options on the expiration date.
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Short Put Assignment – How To Avoid It & What To Do If Assigned
posted on April 28, 2023
You probably sold a Put Option thinking the market would go up.
But now your Short Put is In-the-Money (ITM) and you’re either in danger of getting assigned, or you may have already been assigned the shares.
If you’ve already been assigned, you may be panicking now.
That’s because the unexpected assignment of the shares made your cash balance negative and you could be in danger of a margin call.
In both cases what do you do?
How do you avoid getting assigned if your Short Put is now ITM?
What do you do if you’re already been assigned the shares?
And what do you do if you get a margin call?
What To Do If You Get A Margin Call?
So the most urgent matter to address is if you get a margin call.
If you get a margin call, you want to deal with it immediately.
That’s because if you don’t do anything, your broker can liquidate your positions to meet their margin requirement.
That could mean closing out other positions other than your Short Put position.
So if you have multiple positions, the broker could randomly close positions in your account.
At this point, you have two choices.
The first choice is to add more funds to meet the margin requirement.
The second choice is to close out positions on your own to meet the margin requirement.
According to FINRA (Financial Industry Regulatory Authority), you have two to five days to meet the call:
That should be more than enough time to transfer funds into your account (if you still have more funds), or to close out positions in your account to meet the margin call.
What To Do If Your Short Put Is Assigned
If your Short Put is already assigned, that means you’re now Long 100 shares per Put Option.
In this case, to reverse the assignment and reinstate your original Short Put position, you need to do two things:
- Sell the shares.
- Sell a Put at the same strike but with a longer DTE.
And you do these two things simultaneously in a single order ticket:
By doing it in a single ticket, you do not have any spreading risk because they will move in tandem.
So when you do this, you will reinstate the same Short Put strike but with a longer DTE.
With a longer DTE, there will be more extrinsic value in your Option, which reduces the chances of getting an early assignment.
When You’re In Danger of Early Assignment
The next thing to know is exactly when you’re in danger of getting assigned.
It doesn’t mean that if your Put is ITM, you’d automatically be assigned.
In fact, it’s very rare to get assigned.
The only time you’re likely to get assigned is if the following happens:
- Short Put is ITM.
- And extrinsic value is very little.
- And very few DTE (days to expiration).
The biggest factor that determines whether you have a likelihood of getting assigned is if your extrinsic value is very little.
That’s because when the extrinsic value of the Put is very little, it may not benefit the Put buyer to hold on to the Option.
But as long as there’s still a decent amount of extrinsic value left, you’re unlikely to get assigned even if your Put is ITM.
Understanding The Mindset of Put Buyers
To understand this a little better, we need to get into the mindset of Put buyers and see when they would likely exercise.
Let’s assume you sold a Put on AMZN at the strike price of 120 for $2.00.
Now, let’s switch to the Put buyer’s perspective.
That would mean that the Put buyer bought a Put at the strike price of 120 for $2.00.
The next step is to understand why did this person buy a Put Option.
In general, there are two main reasons why someone would buy a Put Option:
- To speculate a move to the downside (either as a single Option or part of a spread trade ).
- To protect their Long stock position.
Next, we want to map out the different scenarios that can happen and see if the Put buyer would actually exercise their Option in each of the scenarios.
Scenario 1: The stock drops to $115.
Let’s say the stock drops to $115 and the Put Option is now worth $6.00.
So that’s a $4.00 increase in the Put’s value.
Of the $6.00, the value is divided into intrinsic value and extrinsic value:
- Intrinsic value = $5.00
- Extrinsic value = $1.00
When the Put buyer bought the Put, it was just $2.00 of extrinsic value (no intrinsic value because it’s OTM).
After the stock dropped to $115, it gained $5.00 of intrinsic value and lost $1.00 extrinsic value.
Here’s a question for you:
If you were the Put buyer, would you exercise your Put Option?
To know the answer, we want to compare the two choices a Put buyer has at this point.
The first choice is to exercise the Put Option.
By exercising, the Put buyer would either be Short 100 shares at $120, or if the Put buyer already has 100 shares of the stock it would be sold away at $120.
In both cases, when exercising, the Put buyer immediately forfeits the extrinsic value of $1.00.
So if he became Short 100 shares at $120 and immediately sold at $115, his profit would be $5 per share minus the $2 he paid for the Put, which equals $3 profit per share.
If he initially already had 100 shares of the stock, he would be saving $3 loss per share.
The second choice is to just sell off the Put Option.
By selling the Put Option, the Put buyer would have made $4 (bought for $2 and sold for $6).
So in this scenario, it would make more sense for the Put buyer to simply sell off his Put Option than to exercise it.
Scenario 2: The stock drops to $105 with 30 DTE.
In this scenario, the stock has dropped significantly but there’s still 30 DTE left in the Put Option.
The value of the Put has now ballooned to $15.05:
- Intrinsic Value = $15.00
- Extrinsic Value = $0.05
The Put is now deep ITM and there’s very little extrinsic value left.
However, there are still 30 DTE left in the Put Option.
If you were the Put buyer, would you exercise the Put?
In this scenario, it still is unlikely that you’d get assigned because there are still many days left to the Put’s expiration.
If the Put buyer anticipates the stock to fall further, it still makes sense to hold on to the Put until it’s closer to expiration before making a decision to exercise or not.
And if he exercises it, he will forfeit the $0.05 in extrinsic value (which is an additional $5 in profit).
Furthermore, exercising can incur further charges.
So in general, Put buyers would rather just sell off the Put than exercise it.
Scenario 3: The stock drops to $105 with 7 DTE.
In this scenario, the stock also drops to $105 but there’s 7 DTE left.
The value of the Put is now $15.01:
- Extrinsic Value = $0.01
In this case, if you were the Put buyer, would it make sense for you to exercise the Option?
The answer is yes.
That’s because there are not that many days left to the Put’s expiration.
And there’s pretty much no extrinsic value left.
So if your Put doesn’t have much extrinsic value left and there are not many days left to expiration, then it’s highly likely you’d get assigned.
So how do you avoid early assignments?
How To Avoid Early Assignment
The best way to avoid any early assignments is by simply rolling your Short Put .
There are two ways to do this:
- Defensive Method: This method is to proactively roll your Short Put out & down the moment it gets breached to avoid getting ITM. This way you will always keep the delta below 50 so there’s no chance of an early assignment.
- 21 DTE Method: Since we already know that it’s unlikely for an Option to be exercised when there’s still more than 21 DTE left, we only look to roll around the 21 DTE mark. Oftentimes, the Put could be ITM before the 21 DTE mark but is OTM by the time it’s 21 DTE. So if at 21 DTE the Put is ITM, we roll. If it’s OTM, we do nothing and let Theta do its work.
When you use these two methods, the chances of getting assigned on your Short Put get reduced significantly.
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What Is a Put Option?
How a put option works, where to trade options.
Writing Put Options
- Put Option FAQs
The Bottom Line
- Options and Derivatives
Put Option: What It Is, How It Works, and How to Trade Them
James Chen, CMT is an expert trader, investment adviser, and global market strategist.
Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.
A put option (or “put”) is a contract giving the option buyer the right, but not the obligation, to sell—or sell short—a specified amount of an underlying security at a predetermined price within a specified time frame. This predetermined price at which the buyer of the put option can sell the underlying security is called the strike price .
Put options are traded on various underlying assets, including stocks, currencies, bonds, commodities, futures, and indexes. A put option can be contrasted with a call option , which gives the holder the right to buy the underlying security at a specified price, either on or before the expiration date of the option contract.
- Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.
- Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies.
- Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility.
- Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.
- Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.
Investopedia / Theresa Chiechi
A put option becomes more valuable as the price of the underlying stock or security decreases. Conversely, a put option loses its value as the price of the underlying stock increases. As a result, they are typically used for hedging purposes or to speculate on downside price action.
Investors often use put options in a risk management strategy known as a protective put , which is used as a form of investment insurance or hedge to ensure that losses in the underlying asset do not exceed a certain amount. In this strategy, the investor buys a put option to hedge downside risk in a stock held in the portfolio. If and when the option is exercised, the investor would sell the stock at the put’s strike price. If the investor does not hold the underlying stock and exercises a put option, this would create a short position in the stock.
Factors That Affect a Put’s Price
In general, the value of a put option decreases as its time to expiration approaches because of the impact of time decay. Time decay accelerates as an option’s time to expiration draws closer since there’s less time to realize a profit from the trade. When an option loses its time value, the intrinsic value is left over. An option’s intrinsic value is equivalent to the difference between the strike price and the underlying stock price. If an option has intrinsic value, it is referred to as in the money (ITM).
Option Intrinsic Value
Option Intrinsic Value = Difference between Market Price of Underlying Security and Option Strike Price (For Put Option, IV = Strike Price minus Market Price of Underlying Security; for Call Option, IV = Market Price of Underlying Security minus Strike Price)
Out of the money (OTM) and at the money (ATM) put options have no intrinsic value because there is no benefit in exercising the option. Investors have the option of short-selling the stock at the current higher market price, rather than exercising an out-of-the-money put option at an undesirable strike price. However, outside of a bear market , short selling is typically riskier than buying put options .
Time value, or extrinsic value, is reflected in the premium of the option. If the strike price of a put option is $20, and the underlying is stock is currently trading at $19, there is $1 of intrinsic value in the option. But the put option may trade for $1.35. The extra $0.35 is time value, since the underlying stock price could change before the option expires. Different put options on the same underlying asset may be combined to form put spreads .
There are several factors to keep in mind when it comes to selling put options. It’s important to understand an option contract’s value and profitability when considering a trade, or else you risk the stock falling past the point of profitability.
The payoff of a put option at expiration is depicted in the image below:
Put options, as well as many other types of options, are traded through brokerages. Some brokers have specialized features and benefits for options traders. For those who have an interest in options trading, there are many brokers that specialize in options trading . It’s important to identify a broker that is a good match for your investment needs.
Alternatives to Exercising a Put Option
The buyer of a put option does not need to hold an option until expiration. As the underlying stock price moves, the premium of the option will change to reflect the recent underlying price movements. The option buyer can sell their option and either minimize loss or realize a profit, depending on how the price of the option has changed since they bought it.
Similarly, the option writer can do the same thing. If the underlying price is above the strike price, they may do nothing. This is because the option may expire at no value, and this allows them to keep the whole premium. But if the underlying price is approaching or dropping below the strike price, then to avoid a big loss, the option writer may simply buy the option back (which gets them out of the position). The profit or loss is the difference between the premium collected and the premium paid to get out of the position.
Example of a Put Option
Assume an investor buys one put option on the SPDR S&P 500 ETF (SPY) , which was trading at $445 (January 2022), with a strike price of $425 expiring in one month. For this option, they paid a premium of $2.80, or $280 ($2.80 × 100 shares or units).
If units of SPY fall to $415 prior to expiration, the $425 put will be “in the money” and will trade at a minimum of $10, which is the put option’s intrinsic value (i.e., $425 - $415). The exact price for the put would depend on a number of factors, the most important of which is the time remaining to expiration. Assume that the $425 put is trading at $10.50.
Since the put option is now “in the money,” the investor has to decide whether to (a) exercise the option, which would confer the right to sell 100 shares of SPY at the strike price of $425; or (b) sell the put option and pocket the profit. We consider two cases: (i) the investor already holds 100 units of SPY; and (ii) the investor does not hold any SPY units. (The calculations below ignore commission costs, to keep things simple).
Let’s say the investor exercises the put option. If the investor already holds 100 units of SPY (assume they were purchased at $400) in their portfolio and the put was bought to hedge downside risk (i.e., it was a protective put), then the investor’s broker would sell the 100 SPY shares at the strike price of $425.
The net profit on this trade can be calculated as:
[(SPY Sell Price - SPY Purchase Price) - (Put Purchase Price)] × Number of shares or units
Profit = [($425 - $400) - $2.80)] × 100 = $2,220
What if the investor did not own the SPY units, and the put option was purchased purely as a speculative trade? In this case, exercising the put option would result in a short sale of 100 SPY units at the $425 strike price. The investor could then buy back the 100 SPY units at the current market price of $415 to close out the short position.
[(SPY Short Sell Price - SPY Purchase Price) - (Put Purchase Price)] × Number of shares or units
Profit = [($425 - $415) - $2.80)] × 100 = $720
Exercising the option, (short) selling the shares and then buying them back sounds like a fairly complicated endeavor, not to mention added costs in the form of commissions (since there are multiple transactions) and margin interest (for the short sale). But the investor actually has an easier “option” (for lack of a better word): Simply sell the put option at its current price and make a tidy profit. The profit calculation in this case is:
[Put Sell Price - Put Purchase Price] × Number of shares or units = [10.50 - $2.80] × 100 = $770
There’s a key point to note here. Selling the option, rather than going through the relatively convoluted process of option exercise, actually results in a profit of $770, which is $50 more than the $720 made by exercising the option. Why the difference? Because selling the option enables the time value of $0.50 per share ($0.50 × 100 shares = $50) to be captured as well. Thus, most long option positions that have value prior to expiration are sold rather than exercised.
For a put option buyer, the maximum loss on the option position is limited to the premium paid for the put. The maximum gain on the option position would occur if the underlying stock price fell to zero.
Selling vs. Exercising an Option
The majority of long option positions that have value prior to expiration are closed out by selling rather than exercising , since exercising an option will result in loss of time value, higher transaction costs, and additional margin requirements.
In the previous section, we discussed put options from the perspective of the buyer, or an investor who has a long put position. We now turn our attention to the other side of the option trade: the put option seller or the put option writer, who has a short put position.
Contrary to a long put option, a short or written put option obligates an investor to take delivery, or purchase shares, of the underlying stock at the strike price specified in the option contract.
Assume an investor is bullish on SPY, which is currently trading at $445, and does not believe it will fall below $430 over the next month. The investor could collect a premium of $3.45 per share (× 100 shares, or $345) by writing one put option on SPY with a strike price of $430.
If SPY stays above the $430 strike price over the next month, the investor would keep the premium collected ($345) since the options would expire out of the money and be worthless. This is the maximum profit on the trade: $345, or the premium collected.
Conversely, if SPY moves below $430 before option expiration in one month, the investor is on the hook for purchasing 100 shares at $430, even if SPY falls to $400, or $350, or even lower. No matter how far the stock falls, the put option writer is liable for purchasing the shares at the strike price of $430, meaning they face a theoretical risk of $430 per share, or $43,000 per contract ($430 × 100 shares) if the underlying stock falls to zero.
For a put writer, the maximum gain is limited to the premium collected, while the maximum loss would occur if the underlying stock price fell to zero. The gain/loss profiles for the put buyer and put writer are thus diametrically opposite.
Is Buying a Put Similar to Short Selling?
Buying puts and short selling are both bearish strategies, but there are some important differences between the two. A put buyer’s maximum loss is limited to the premium paid for the put, while buying puts does not require a margin account and can be done with limited amounts of capital. Short selling, on the other hand, has theoretically unlimited risk and is significantly more expensive because of costs such as stock borrowing charges and margin interest (short selling generally needs a margin account). Short selling is therefore considered to be much riskier than buying puts.
Should I Buy In the Money (ITM) or Out of the Money (OTM) Puts?
It really depends on factors such as your trading objective, risk appetite, amount of capital, etc. The dollar outlay for in the money (ITM) puts is higher than for out of the money (OTM) puts because they give you the right to sell the underlying security at a higher price. But the lower price for OTM puts is offset by the fact that they also have a lower probability of being profitable by expiration. If you don’t want to spend too much for protective puts and are willing to accept the risk of a modest decline in your portfolio, then OTM puts might be the way to go.
Can I Lose the Entire Amount of the Premium Paid for My Put Option?
Yes, you can lose the entire amount of premium paid for your put, if the price of the underlying security does not trade below the strike price by option expiry.
I’m New to Options and Have Limited Capital; Should I Consider Writing Puts?
Put writing is an advanced option strategy meant for experienced traders and investors; strategies such as writing cash-secured puts also need a significant amount of capital. If you’re new to options and have limited capital, put writing would be a risky endeavor and not a recommended one.
Put options allow the holder to sell a security at a guaranteed price, even if the market price for that security has fallen lower. That makes them useful for hedging strategies, as well as for speculative traders. Along with call options, puts are among the most basic derivative contracts.
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What is a put option assignment?
Put Option Assignment
Put option assignment is a trading term used in the options market, specifically in the context of put options. It refers to the process by which the seller of a put option is obligated to buy the underlying asset at the strike price from the buyer of the put option.
When a put option is assigned, it means that the buyer of the put option has exercised their right to sell the underlying asset at the strike price, and the seller of the put option must fulfill their obligation to purchase the asset.
Put option assignment typically occurs when the price of the underlying asset falls below the strike price of the put option. This allows the buyer of the put option to sell the asset at a higher price than its current market value, resulting in a profit for the buyer.
Upon assignment, the seller of the put option is required to buy the asset at the strike price, regardless of its current market price. This can lead to potential losses for the seller if the market price of the asset is significantly lower than the strike price.
It is important for options traders to be aware of the possibility of put option assignment and understand the associated risks. Traders who sell put options should carefully consider their risk tolerance and have a clear strategy in place to manage potential assignment scenarios.
Overall, put option assignment is a crucial aspect of options trading, as it represents the fulfillment of contractual obligations between the buyer and seller of a put option. Understanding the mechanics and implications of put option assignment is essential for successful options trading.
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