Early assignment occurs when the owner of an option contract exercises it before the expiration date.
This means that if you're short an options contract (either a call or put), you may be required to fulfill your obligations as the seller of the contract before the expiration date.
If you have sold a put, you could be called upon to buy 100 shares at the strike price.
If you have sold a call, you could be forced to sell 100 shares at the strike price.
Why Does Early Assignment Happen?
Technically, an option can be assigned at any time.
However, it tends to only happen when the option is in-the-money and there is very little time premium left.
Ex-dividend dates can also impact early assignment as some traders will exercise a call option early in order to received the dividend payment.
Let’s look at some examples:
AAPL at $171
The $175 put is trading at $5.70.
The put option is in-the-money with $1.70 of time premium remaining, therefore is unlikely to be assigned early.
The $165 call is trading at $8.00.
The call option in in-the-money with $3.00 of time premium, therefore is unlikely to be assigned early.
The $185 put is trading at $14.00
The put option is in-the-money with $0.00 of time premium remaining, therefore is very likely to be assigned early.
Risks of Early Assignment
The risks associated with early assignment revolve around the obligations on the option seller.
If the option buyer exercises their right to buy or sell the underlying asset, the seller MUST fulfil their obligation.
Being called upon to buy 100 shares could result in a margin call if the investor does not have the required capital.
Early Assignment and Credit Spreads
Let’s assume you sold a 100-95 bull put spread and the stock has dropped to 90 near expiration.
If you are assigned on the 100 put, you can exercise the 95 put.
The two offset and you are left with 0 shares.
Where is gets tricky is if the stock is trading between 95 and 100 near expiration.
Automatic Assignment
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.
Conclusion
Early assignment is a risk that all options traders should be aware of and prepared to manage.
As you navigate the dynamic landscape of the financial markets, a mastery of these Greeks opens the door to a strategic and informed approach.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
