What Is Options Trading Assignment?

Options assignment occurs when the buyer of an options contract exercises their right, and the seller (also known as the options writer) must fulfill the contract. This means that if you’ve sold an option, you could be required to deliver the underlying asset or cash based on the terms of the contract.

For example, if you sell a call option on a stock and the buyer exercises their option, you must deliver the stock at the agreed strike price. On the other hand, if you’ve sold a put option, you’ll need to purchase the stock at the strike price.

Why Options Get Assigned

Options are usually assigned when the option is "in the money," meaning that it is advantageous for the option holder to exercise it. For example, if a stock is trading at $60 and you sold a call option with a strike price of $50, the buyer has every reason to exercise the option, forcing you to sell at a lower price. Market conditions, volatility, and the time left before expiration all play roles in whether an option gets assigned.

How Options Assignment Works

For an option to be assigned, the buyer must choose to exercise the option. When an option is exercised, the seller or writer of the option is "assigned" the obligation to deliver (in the case of a call option) or buy (in the case of a put option) the underlying asset. This assignment process can happen at any time if the option is of the American style, whereas European-style options can only be assigned on the expiration date.

Exercising an Option

When the buyer of an option decides to exercise it, they take action based on the terms of the contract. Exercising can either mean purchasing or selling the underlying asset, depending on whether the option is a call or put. The seller must comply with the buyer’s decision.

When Does an Assignment Occur?

Assignments can happen at any time between the moment you sell a short option (write an option) and its expiration. However, most assignments occur when the contract is in-the-money (ITM), which means the option’s strike price is favorable compared to the current market price.

• American-style options: These options can be exercised at any time before expiration, which means the writer can be assigned at any moment within the lifespan of the contract.
• European-style options: These can only be exercised on the expiration date, meaning the risk of assignment is limited to that specific time.

The risk of early assignment is more prevalent with American-style options, adding an element of unpredictability to the equation.

Call vs. Put Assignment

In a call option, the buyer has the right to purchase the underlying asset at a predetermined price. If the option is assigned, the seller must sell the asset to the buyer at the agreed price, even if the market value is much higher. This can lead to significant losses if the price skyrockets.

A put option gives the buyer the right to sell the underlying asset at a set price. If assigned, the seller is obligated to buy the asset from the buyer, which can also result in losses if the asset’s market price has drastically dropped.

The Role of the Options Buyer and Seller

In the options market, there are two primary roles: the buyer and the seller (or writer). The buyer holds the right to exercise the option, while the seller is obligated to fulfill the contract if the buyer decides to exercise. The buyer pays a premium to the seller for this right, and if the option is assigned, the seller is legally bound to complete the transaction.

Different Types Assignments

Standard Assignment

In a standard options assignment, the contract is exercised by the buyer because the option is profitable (ITM). In this scenario, the writer is assigned and must fulfill the obligation. Here's a breakdown:

• Call option assignment: The seller must sell the asset at the strike price, often below the current market value.
• Put option assignment: The seller must buy the asset at the strike price, often above the current market value.

Early Assignment

Early assignment occurs when the buyer exercises the option before the expiration date. This situation mostly arises in American-style options and is typically triggered by factors such as dividend payouts. A buyer might exercise the option early to capture dividends from holding the underlying asset.

Early assignment carries risks for the option writer, as the obligation to buy or sell the asset can occur unexpectedly, sometimes leading to unfavorable financial positions.

Partial Assignment

A partial assignment happens when only a portion of the written contracts are assigned. For example, if you wrote 10 contracts, the options clearinghouse might assign only a part, such as 5 contracts. This often occurs when there's a high volume of contracts being exercised, and the clearinghouse distributes assignments proportionally.

Partial assignments may limit the writer's exposure but still involve risk, as there is no way to predict how much of your position might be assigned.

Random Assignment

In options trading, assignments are done on a random basis by the Options Clearing Corporation (OCC). When an option is exercised, the OCC assigns the obligation to a randomly selected writer. Traders have no control over when or if they will be assigned, which adds an element of chance to the risk management process.

Cash-Secured and Covered Call Assignments

In a cash-secured put assignment, the seller must have sufficient cash to purchase the underlying asset if the buyer exercises their right to sell. Similarly, with covered call options, the seller must own the underlying asset to deliver it if assigned.

The Risks of Options Assignment

Options assignment carries various risks depending on whether you're the buyer or seller of the contract.

Risk for Option Sellers

For the seller, assignment can come with significant risks. If you're assigned on a short call, you'll be obligated to sell the underlying asset at the strike price. If the market has moved higher, you could be forced to sell at a loss. Similarly, if you're assigned on a short put, you'll be required to buy the underlying asset, which can result in financial strain if the price has dropped significantly.

Risk for Option Buyers

Buyers of options face less risk when it comes to assignment, but it can still be impactful. If a call buyer fails to exercise a profitable contract, they miss out on potential gains. On the flip side, put buyers can see their holdings depreciate if they don't assign the contract in time.

Early Assignment Risk

One of the most important factors in options trading is the risk of early assignment. American-style options can be assigned at any point before expiration. This adds an element of uncertainty, especially if the position moves against you while the option is still open. Traders need to be vigilant of this, particularly when dealing with dividend-paying stocks, where early assignment is more likely.

Market Risk

Market risk is the most obvious one. If the market moves against your position after assignment, you could face substantial losses. 

Liquidity Risk

Liquidity risk refers to the chance that you might not be able to close out your position efficiently due to a lack of buyers or sellers in the market.

When an option is assigned, the seller may need to meet additional margin requirements. This can mean tying up more capital in the trade, which can limit your ability to make other trades.

Managing Assignment Risk

To manage assignment risk, traders often use strategies like rolling options to a later expiration date or closing positions before they become a liability. Hedging with other options or holding cash reserves can also help mitigate the impact of an assignment.

 

Conclusion

Options assignment is a crucial concept for any options trader. Understanding the different types of options assignments and their associated risks is vital for any options trader.

Assignments can happen unexpectedly, especially with American-style options, and traders must be prepared to handle the financial implications. From market risk to early assignment risk, managing assignments is crucial to maintaining a successful options trading strategy.

By employing careful risk management techniques and staying informed about market conditions, traders can mitigate the impact of options assignments on their portfolio.

 

Use Code "BLOG" to receive 25% Off Your Next Purchase!