Assignment in Options Trading
What is an Options Assignment?
In options trading, an assignment occurs when an option is exercised.
As we know, a buyer of an option has the right but not the obligation to buy or sell an underlying asset depending on what option they have purchased. When the buyer exercises this right, the seller will be assigned and will have to deliver or take delivery of what they are contractually obliged to. For stock options, it is typically 1,000 shares per contract for the UK; and 100 shares per contract in the US.
As you can see, a buyer will never be assigned, only the seller is at risk of assignment. The buyer, however, may be auto exercised if the option expires in-the-money.
The Mechanics of Assignment
Assignment of options isn’t a random process. It’s a methodical procedure that follows specific steps, typically beginning with the option holder’s decision to exercise their option. The decision then gets routed through various intermediaries like brokers and clearing +houses before the seller is notified.
- Exercise by Holder: The holder (buyer) of the option exercises their right to buy (for Call) or sell (for Put).
- Random Assignment by a Clearing House: A clearing house assigns the obligation randomly among all sellers of the option.
- Fulfilment by the Writer: The writer (seller) now must fulfill the obligation to sell (for Call) or buy (for Put) the underlying asset.
Option Assignments: Calls and Puts
Call Option Assignments
When a call option holder chooses to exercise their right, the seller of the call option gets assigned. In such a situation, the seller is obligated to sell the underlying asset at the strike price to the call option holder.
Put Option Assignments
Similarly, if a put option holder decides to exercise their right, the put option seller gets assigned. The seller is then obligated to buy the underlying asset at the strike price from the put option holder.
The Implications of Assignments for Options Traders
Understanding assignment in options trading is crucial as it comes with potential risks and rewards for both parties involved.
For Option Sellers
Option sellers, or ‘writers,’ face the risk of unexpected assignments. The risk of being assigned early is especially present for options that are in the money or near their expiration date. We explain the difference between American and European assignments below.
For Option Holders
For option holders, deciding when to exercise an option (potentially leading to assignment) is a strategic decision. This decision must consider factors such as the intrinsic value of the option, the time value, and the dividend payment of the underlying asset.
Can Options be assigned before expiration?
In short, Yes, but it depends on the style of options you are trading.
American Style – Yes, this type of option can be assigned on or before expiry.
European Style – No, this type of option can only be assigned on the expiry date as defined in the contract specifications.
Options Assignment Example
For example, an investor buys XYZ PLC 400 call when the stock is trading at 385. The stock in the coming weeks rises to 425 after some good news, the buyer then decides to exercise their right early to buy the XYZ PLC stock at 400.
In this scenario, the call seller (writer) has been assigned and will have to deliver stock at 400 to the buyer (sell their stock at 400 when the prevailing market is 425).
An option typically would only be assigned if it is in the money, considering factors like dividends which do play an important role in exercise/assignments.
Can an Options Assignment be Prevented?
Assignment can sometimes come as a bit of a surprise but normally you should see it coming. You can only work to prevent assignment by closing the option before expiry or before any possible risk of assignment.
Managing Risks in Options Trading
While options trading can offer high returns, it is not devoid of risks. Therefore, understanding and managing these risks is key.
Buyers Risk: The premium paid for an option is at risk. If the option is not profitable at expiration, the premium is lost.
Writers Risk: The writer takes on a much larger risk. If a call option is assigned, they must sell the underlying asset at the strike price, even if its market price is higher.
Options Assignment Summary
The concept of ‘assignment’ in options trading, although complex, is a cornerstone of understanding options trading. It not only clarifies the responsibilities of an options seller but also helps the traders to gauge and manage their risks more effectively. Successful trading involves not just knowing your options but also understanding your obligations.
Options Assignment FAQs
What is options assignment?
Options assignment refers to the process by which the seller (writer) of an options contract is obligated to fulfill their contractual obligation to buy or sell the underlying asset, as specified by the terms of the options contract.
When does options assignment occur?
Options assignment can occur when the buyer of the options contract exercises their right to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset before or at expiration.
How does options assignment work?
When a buyer exercises their options contract, a clearing house randomly assigns a seller who is short (has written) the same options contract to fulfill the obligations of the exercise.
What happens to the seller upon options assignment?
If assigned, the seller (writer) of the options contract is obligated to fulfill their contractual obligation by buying or selling the underlying asset at the specified price (strike price) per the terms of the options contract.
Can options be assigned before expiration?
Yes, options can be assigned at any time (depending on contract type) before expiration if the buyer chooses to exercise their right. However, it is more common for options to be assigned closer to expiration as the time value diminishes.
What factors determine options assignment?
Options assignment is determined by the buyer’s decision to exercise their options contract. They may choose to exercise if the options contract is in-the-money and it is financially advantageous for them to do so.
How can I avoid options assignment?
As a seller (writer) of options contracts, you can avoid assignment by closing your position before expiration through a closing trade (buying back the options contract) or rolling it over to a future expiration date.
What happens if I am assigned on a short call option?
If assigned on a short call option, you are obligated to sell the underlying asset at the specified price (strike price). This means you would need to deliver the shares. To fulfill this obligation, you may need to buy the shares in the open market if you do not hold them.
What happens if I am assigned on a short put option?
If assigned on a short put option, you are obligated to buy the underlying asset at the specified price (strike price). This means you would need to purchase the shares.
How does options assignment affect my account?
Options assignment can impact your account by requiring you to fulfill the obligations of the assigned options contract, which may involve buying or selling the underlying asset. It is important to have sufficient funds or margin available to cover these obligations.