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How Does Assignment Work?

Posted by Pete Stolcers on July 17, 2008

Option Trading Question

Robert states, "My question regards the assignment of options. I'm not exactly sure how the dynamics work and how to determine if I'm in danger of being assigned. Suppose I sell a call, when does the person on the other side get to buy the call you put up for sale?

Option Trading Answer

Great question. Before I get started, let me clarify a point. The person does not get to buy the call, he gets to buy the stock at the strike price.

The answer is relatively involved so I will try to answer it in stages. First of all, let’s keep it simple and say that you sold a front month call for $2 and it expires in 3 weeks. The stock was at $48 and the call had a strike price of $50. As the seller, you have no rights (you are at the mercy of the buyer). The buyer of the call has the right to buy the stock at $50. If he elects to exercise that right, you are obligated to sell him shares at $50. Obviously, with the stock at $48 he will not elect to do that. He can go into the open market and buy shares for less than $50. The option is out-of-the-money (OTM).

Now let’s say the stock has rallied and it is currently trading for $52 with a week left until expiration. The options are in-the-money (ITM) and they have value. In this case, the options are worth $2. The option buyer could elect to sell the shares of stock in the open market for $52 and exercise his call options. Effectively he is selling the stock at $52 and buying it at $50. The difference is $2 and that represents the intrinsic value (parity). Since there is still a week before expiration, the option will carry some premium above and beyond parity. If the $50 call is trading for $2.50, the buyer of the option will simply sell it in the open market. In doing so, he will get $2.50 instead of $2.00. If he sells the option in the open market, no one gets assigned.

Let’s suppose we are in the home stretch and it is expiration week. With three days to go, the stock is trading at $53.90 x $54.00 and the option is trading $3.80 x $4.10. The option buyer looks at the market and figures he might be able to split the bid/ask and sell the stock for $53.95. Once he is filled he exercises his call and effectively gets out of the trade for $3.95. That is $.15 better than if he sold the option in the open market for $3.80.

The option buyer must submit his exercise notice no later than 15 minutes after “the bell” in any given day. This rule is in place so that he can’t force delivery based on news that comes out “after hours” on expiration Friday.

Once an exercise has been submitted by the brokerage firm to the OCC (Options Clearing Corp) there is a standardized method of allocating the assignment to each of the brokerage firms that have a short position in that option. The brokerage firm will receive their allotment from the OCC and through a standardized lottery system. they will determine which accounts in the firm get assigned. The communication that takes place between the brokerage firm and the customer once that happens varies from one firm to another. If there is a long stock position to offset the short stock, they will normally flatten out the position.

If you were short a call option and you were assigned, you will come in the next day short stock. If you buy in your short stock that day, you are permitted to use a rule called “same day substitution” that prevents you from having to put up the short stock margin.

You will run the risk of assignment when the option is bid below parity. That will only happen if the option is ITM. If it is barely ITM, it might not trade below parity until the last few minutes. If it is ITM by less than $1, it will probably trade under parity the day of expiration. If it is ITM by more than $4, the option can trade below parity a week or even two before expiration if the stock is not very volatile. I have seen options that are ITM by more than $15 get assigned a month before expiration. Look at the bid of the option to figure out if you run the risk of assignment.

Here is an important point to remember. In the case of a call option, if the stock is bid more than a quarter of a point higher than the strike (i.e $50.25) at the close on expiration Friday, it will go through auto exercise/assignment. That is why it is important to close at-the-money positions out at expiration unless you don’t mind delivery. The buyer may not want to take delivery of the stock but if he leaves the position open, he will be long shares of stock Monday morning.

There are many twists and turns to assignment on cash settled American Style options like the OEX. You’d better know the intricacies or it could cost you a lot of money.

Thanks for the question Robert. You just won a one month subscription to the OneOption service of your choice.

Option Trading Comments

  • On 06/30, Louis Meluso said:

    RE. Assignment

    If an account had a synthetic long stock position, let’s say, deep ITM Put and Call same strikes postion and the more valuable option got exercised, would the clearing firm, OCC, use the oppossing option to settle?

  • On 07/01, Pete Stolcers said:

    Hi Louis,

    The answer is no. In a synthetic, if you had an ITM put, that would mean that the call is OTM. You would be long the stock after assignment and long an OTM call. If you wanted to exit, you would sell the stock. The brokerage firm or Options Clearing Corp. (OCC) would screw you if they excercised the call because you would be paying more for the stock (strike price) than the stock was trading for in the open market.

    Hope this make sense.

  • On 03/21, V. Togeson said:

    Greetings and thanks for your answer...I am long the stock come exp friday and long a deep itm put as a hedge...the put was in the money at exp and was never exercised (my bad) on exp friday...come Monday, where will I stand????...thanks

  • On 03/21, Pete Stolcers said:

    It is always easier for readers to understand the reponse when real numbers are provided.

    If you are long a stock that is trading at $95 and long a $100 put (deep ITM) then you will be auto-assigned. The Option Clearing Corp (OCC) assigns all options that are more than $.15 in-the-money.

    Come Monday, you will be flat. You will have sold stock at $100 via the exercise of your puts.

  • On 04/05, S. Seidler said:

    I am new to this. If I buy a call option at $2.00, what amount is the most I can lose? Is it the stock price or call price?

  • On 04/07, Pete Stolcers said:

    The most you can lose when you buy a call option or a put option is the premium paid. In your case, it is $2.

  • On 09/15, Jay said:

    You may have already answered this but....

    If I am “EARLY” assigned on the short leg of an options spread on say “Tuesday” of the expiration week, and this happens 20 minutes before market close for the day, how does Same-day-substitution work in this case? For instance if I have a bull call debit spread and I have purchased the 30 call option for symbol xyz—and shorted the 35 call option stock symbol xyz. If I am assigned the short leg of the option spread 20 minutes before market close for that day (again say it is Tuesday the week of expiration i.e. EARLY assignment) must I execute the long leg of the spread or put up the shares of xyz that SAME DAY (Tuesday) within this narrow 20 minute period? Does same day substitution give me only 20 minutes in this scenario to provide the shares or exercise my long position or am I notified after hours and then I have the next day to handle this situation? I hope it is the case that I would have next day to deal with the short assignment of the spread. If I only have 20 minutes to respond to the assignment, how could I avoid this other than always unwinding spreads weeks out? And my broker said they would NOT automatically exercise my long call leg of the spread to close the spread and that I was responsible for doing that.

  • On 09/15, Pete said:

    Assignment is not known until after the market closes and you do have the entire next day to dael with it.

  • On 09/17, Jay said:

    Thank goodness! No one else I ever asked explained that assignment occured after the market had closed for the day, or else I don’t remember anyone else mentioning that.

    Thanks for answering.

  • On 10/31, Gano Ramorino said:

    Discovered you today. Great.
    You already answered two big questions I had
    with your answer to Robert.
    Here’s another one: I wrote a strangle and I’m early assigned on the call but without knowing it and fearing it I closed the position buying back the strangle at a cost. What happens to me? When do I know that I was assigned(depends from the broker ?)? There could be a big change in the price of the stock, negative for me, before I can buy it to deliver. I am very confused and worried about this lack in certainty about trading options. Specially the timings involved in the things I said before are very confused to me.
    Thanks a lot.
    Best regards from Gano

  • On 11/01, Pete Stolcers said:

    The assignment process only starts after the closing bell. If you closed the position during trading hours, there is no way you could get assigned. Brokerage firms receive notification from the OCC after the close. Then the brokerage firm, through a lottery, determines which accounts (with an open position) will get assigned. Bottom line, buy in your short and there is no chance for assignment.

    Instead of selling naked strangles, buy a far OTM option for protection. That will reduce your fear and risk.

    Selling naked strangles requires a huge account and vast experience. It is the riskiest option strategy and there are suitability rules that brokerage firms have to obey. Most firms won’t approve you for the strategy. Make sure you know all of the ins and outs before you start.

  • On 06/19, dave said:

    You state auto assignment is executed if the PPS is more that 0.25 higher than the strike.

    I believe this has been amended to 0.05 higher than the strike...THEN auto assignment is triggered.

    Can you confirm this?

  • On 06/22, Pete Stolcers said:

    Yes this has changed.

    The OCC’s (Option Clearing Corp)threshold for auto assignment is $.01 in the money. Each brokerage firm sets their own threshold and traders need to check the policies before trading.

  • On 10/20, Duc Tran said:

    My broker said if I get assigned for my Short November Call, I can offset the assignment by exercising my Long December Call. This is done without having to buy any shares. Is this correct because wouldn’t this be a day late?

  • On 10/20, Pete Stolcers said:

    When you are assigned on a short option position, you have one day to react without having to meet normal margin requirements. This is known as same day substitution.

    You can exercise your long Dec call, but that would not be the most effidient way to exit the trade. Chances are, the options still carry some time premium. You would buy the shares of stock you are short (due to Nov assignment) and sell the Dec calls in the open market.

    The only exception to this would be if the Dec calls are trading at parity or a discount. Then you would exercise them.

  • On 12/26, Jim said:

    I am buying a debit spread in a fairly expensive stock where I buy 1 ATM $600 call for $12.00 and sell 1 $620 call for $5.00. if the stock runs to $650 in a couple of days (expiration is 30 days away) and I am early assigned on the short $620 call, do I need $60,000 in my account to exercise my $600 call to buy the stock to cover the assignment? How would this work?

  • On 12/28, Pete Stolcers said:

    You can immediately exercise your $620 call after being assigned without any margin requirement. You would want to do it right away since you have maxed out on the trade.

  • On 03/21, Denise said:

    I had a $65.00 calendar call spread on BUCY.  The short portion was the March 65s and the long was Apr 65s.  The stock closed Friday (option exp) @ 65.05 last, although I did not see that price until a few minutes afetr 4:00pm.  I left the short side open thinking it would expire worthless.  Now I see that I have a “potential maint call” of $26,800 + a “potential day trade call” of $145,770.  I’m confused.  The highest BUCY traded for after hours was $65.056 and the lowest was $64.8537.  The highest it sold for inn the 15 minutes after the close was $65.043.  What did I do wrong?  Thanks

  • On 03/22, Pete Stolcers said:

    It is often best to buy the options back for $.05 when they are right at the strike.

    The alternative is to wait and see if you are assigned. If you come in short stock Monday, you can buy the shares back that day without putting up the margin. That is known as same day substitution. If the stock spiked, you could also exercise your calls to flatten out. This is not as desireable since the calls are likely to carry premium.

    Buy the stock back and sell the calls to unwind.

  • On 06/19, Matt Headley said:

    My question is on option assignment.  If I am long a put spread where the long and short positions expire in the money.  Will the positions be netted against each other at expiration and just credit me the difference?  I didn’t know if there was any reason to close out the position prior to expiration?

  • On 06/22, Pete Stolcers said:

    You are correct. Both positions will be assigned/exercised and the difference in the strike prices will be credited or debited (depending on if you bought or sold the spread). No action required.

  • On 08/29, Mike said:

    I had a call credit spread on SPY - short at $118, long at $120 on closing Friday (weekly option).  At market close, SPY was at $117.97.  After hours, the stock crept to 118.20.  I ended up getting assigned short shares.  Is this consistent with the “rules?”

  • On 08/30, Pete Stolcers said:

    Yes, that is consistent with the rules. Often there are stock buy imbalances on the close and it take a few minutes for the cash index (ETF) to catch up. All of the stocks in the basket are in a flux as they settle.

    Regardless, the owner of the calls does have time after the close to exercise the calls. Most borkerage firms have a 30 minute “window\” to submitt the exercise notice to the OCC.

    Best practice is to buy the options back if they are close to the strike. Then you can avoid the risk.

  • On 09/16, Patricia Bianco said:

    I have a short call vertical where both legs are in the money at expiration.  So they balance each other out ... “no action required”.  It’s just 2 contracts & one thing I learned is my brokerage charges $15 to exercise and $15 to assign, a total of $30.  In my case then it’s cheaper to pay the commission to close the position.

  • On 09/20, Pete Stolcers said:

    I don’t know what your commissions are, but if it is a $5.00 spread, you won’t be able to sell it for that. The Market Makers have no incentive to take you out at $5.00. They will bid $4.95 for the spread and then they can make $.05. Given the extra $.05, auto exercise/assignment might make sense even though the commissions are a little higher.

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