Weekly Option Trader

Early Assignment

I’ve heard it said that most options expire worthless. This claim generally comes from non-option traders trying to convince would-be traders not to start. It’s just not true. The vast majority of option positions are simply closed before expiration. Even though a large number expire, plenty are exercised/assigned.

The term exercise refers to an option buyer exercising their right granted by the option. Call buyers have the right to buy stock at the strike price anytime before the option expires. Put buyers have the right to sell stock at the strike price anytime before the option expires. Their act of doing so is known as exercising.

The term assignment refers to an initial option seller, also know as the option writer, being exercised by the buyer of their option. Call writers have the obligation to sell stock at the strike price anytime before the option expires. Put writers have the obligation to buy stock at the strike price anytime before the option expires. When they are forced to fulfill their obligation, it is known as being assigned.

The last day for option buyers to exercise their rights and option writers to be assigned their obligations is on expiration Friday. Technically, option expiration happens the Saturday following the third Friday. Since the stock market is closed on Saturdays and since most brokerages also make their retail clients announce their intentions by the third Friday, most people consider this day as option expiration day.

On stock options, the buyer of an option can exercise their right at any point until expiration. That is any time they want, but it won’t reflect when the market is still open. The shares will trade hands after normal hours. Disappearing from the assigned Call writer’s account and/or appearing in the assigned Put writer’s account, before the open of the next business day. Their broker should inform them of assignment before the market opens.

Most exercise/assignment takes place on the last day, expiration day. But since stock option buyers can exercise their rights at anytime until expiration, it is possible to take place “ahead of schedule.” When an option buyer chooses to do so, it is known as early exercise. Logically, when the writer receives notification, it’s known as early assignment.

Selling Naked Puts has its own risks and rewards. Some aspects, which are thought to be risks, may actually be rewarding. Early Assignment falls into this category.

Calls are almost never exercised early. If their buyer does so, he has to come up with the money to pay for the stock. On the other hand, Put buyers often exercise early. When they exercise their right to sell stock, they get paid. They collect the money for the sale. I’ve been assigned early on Puts numerous times. I’ve been called out early only once in the last few years. I know very few Covered Call writers that have ever been called out early. Money has value; it collects interest. Follow the money!

Time Merchant

Selling options is akin to selling time. Option writers collect premium by obligating themselves for certain periods of time. If the buyer of those options decides not to exercise the time will expire and with it the option. But if the option buyer chooses to exercise early, they aren’t using time they’ve previously paid for. Maybe it can be resold.

Option buyers can sell their options anytime the market is open. As long as there is time value remaining, they would be foolish to exercise. By doing so they lose the time value. If and when they do, they have to lose it to someone. That someone could be you. Be aware, this opportunity generally never avails itself, but when it does, be prepared to profit.

Usually options are only assigned early when they are so Deep In the Money (DITM) they have no time value. Also early assignment might happen one or two weeks before expiration, but not often any earlier than the last week before.

How To Profit When Assigned Early Using a Totally Hypothetical Example:

Stock XYZ closed @ $ 33. The $ 40 Puts closed @ $ 7.50 bid, $ 8.00 ask. Their intrinsic value equals the amount In the Money (ITM) $ 7. Whatever remains forms the time value, in this case less than a dollar. But instead of selling the Puts on the open market, their buyer chooses to exercise early. If we wrote these Puts and were the early assignment “victim,” we could receive a windfall profit.

There’s two ways to resell the time. One way is to sell a Covered Call against the stock just bought. If the prices remain the same the following day when we found out we were assigned early, the $ 40 Call should be priced around $0.50 bid, $0.75 ask. Although we may get a better price than bid, let’s assume we sell the Call @ $0.50. If the stock rises above $ 40 and we get called out; it’s the same net effect as never being Put in the first place. We would NOT own the stock, but we would have picked up an extra $0.50.

Selling options can be very profitable. To the trained trader the numerous risks are more than offset by the potential rewards, including those that almost never appear. Training comes from experience; not necessarily one’s own. Being aware of circumstances that hardly ever appear allows profits if/when they do appear.