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.