by The Options Industry Council | April 13, 2011 5:29 pm
Q: I was assigned on my March 40 put option when the stock value went below $38, even though it wasn’t expiration. On another stock, I had a covered write position where I was short a 70 call which went in-the-money by $7, and the call wasn’t assigned until expiration day. How can I tell when I will be assigned?
A: The short answer is that you can never tell when you will be assigned. Once you sell an option (put or call), you have the potential for being assigned to fulfill your obligation to receive (and pay for) or deliver (and get paid for) shares of stock on any business day. In some circumstances, you may be assigned on a short option position while the underlying shares are halted for trading, or perhaps while they are the subjects of a buyout or takeover. To ensure fairness in the distribution of equity and index option assignments, The Options Clearing Corporation utilizes a random procedure to assign exercise notices to the accounts maintained with OCC by each Clearing Member. The assigned firm must then use an exchange approved method (usually a random process or the “first-in, first-out” method) to allocate those notices to accounts which are short the options.
Having said that, there are some generalizations which might help you understand when you might be more likely to be assigned on a short-option position.
The bottom line is that you really don’t have any sure-fire way to predict when you will be assigned on a short option position; it can happen any day the stock market is open for trading.
A: The option holder has the right to exercise his or her options position prior to expiration regardless of whether the options are in- or out-of-the-money. You can be assigned if an investor or market professional holding calls of the same series as your short position submits an exercise notice to his or her brokerage firms, which in turn, submitted an exercise notice to The Options Clearing Corporation (OCC) (or if the brokerage firm is not an OCC Clearing Member, then it would submit the notice to a firm that is an OCC Clearing Member, and that Member would then submit the notice to OCC). OCC randomly assigns exercise notices to Clearing Members in whose accounts have short positions of the same series. The Clearing Member then assigns the exercise to one of its short positions using a fair assignment method, though not necessarily random. You should ask your brokerage firm how it assigns exercise notices to its customers.
A: No, it is not possible. The assignments are determined based on net positions after the close of the market each day. Therefore, if you bought back your short call, you no longer have a short position at the end of the day, and therefore no possibility of being assigned.
A: The exercise of an option prior to expiration is solely at the discretion of the buyer. The option buyer can also decide how many contracts in a multi-contract position to exercise at a given time. Once an exercise notice is tendered, The Options Clearing Corporation randomly selects for assignment a member brokerage firm carrying a short position in that series. The brokerage firm may, in turn, assign the notice randomly, or on a “first-in, first-out” basis. Regardless of what method is applied by the brokerage firm, equity options writers are subject to the risk each day that some or all of their short options may be assigned.
A: OCC’s Clearing Members can submit exercise notices, on a daily basis, up to 7:00 p.m. Central Time, and in general each Clearing Member will establish its own (earlier) deadline for its customers. (There is a different set of procedures for expiring options.) As part of its nightly processing, OCC randomly assigns its Clearing Members based on the days exercises. This processing is completed at approximately 1:00 a.m. Central Time. OCC transmits the assignments to its Clearing Members and as part of the Member’s nightly processing, they allocate the assignments to their customers on either a random basis or a first in – first out basis.
We understand the exchanges’ rules are that customers should be notified of assignments in a timely manner. It is best that you and your broker determine what constitutes ‘timely manner’ beforehand: Does ‘timely manner’ mean a call the morning of the assignment? Is there an update to your account that you can view online? Will you receive a letter in the mail?
For expirations, OCC process all exercise/assignments on Saturday. OCC’s processing is completed and transmitted to its Clearing Members late Saturday night. Clearing Members will process expiration exercises and assignments on Sunday and then notify their customers the next business day. Once again, you can probably get an approximation from your broker.
Q: I recently wrote a call option. At the market close on expiration Friday, the option was 41 cents (.41) in-the-money. My broker told me that calls are “automatically” assigned when they are a certain amount in the money at expiration. Is there is a way that I can avoid being assigned?
A: While each firm may have their own thresholds, the Option Clearing Corporation’s auto exercise threshold is 1 cent (.01) in the customers account. (The automatic exercise threshold in firms and market makers accounts is 1 cent (.01).) Customers and Brokers should check with their firm’s Operations Department to determine their company’s policies regarding exercise thresholds. An option holder has the right to exercise their option regardless of the price of the underlying security. It might be a good practice for all option holders to express their exercise – or non-exercise – instructions to their broker. Is there a magic number that ensures that option writers will not be assigned? The answer would be ‘NO’. Although unlikely, an investor may choose to exercise a slightly out of the money option or choose not to exercise an option that is in the money by greater than 1 cent (.01).
Some investors use the saying, “when in doubt, close them out”. This means that if they buy back any short contracts they are no longer at risk of being assigned.
A: The most obvious and straight forward action would be to close out the position by buying the call back. While this may not be attractive and may result in a loss, or less than hoped for gain, it will assure that your stock will not be called away. Some alternatives to being assigned are to “roll out and up”. To roll out and up involves buying back the current option and selling a higher strike in a further out month. This may allow an investor to gain some additional time premium and added stock appreciation. You will want to consult your broker for any advice on this strategy.
A: You will first need to check with your broker to ensure that an assignment has not already occurred. If not, here is how processing occurs:
At the end of the day, the Options Clearing Corporation accumulates all option exercises. Prior to processing exercises, OCC’s clearing system accumulates all post-trade transactions and matched-trades together and applies them to Clearing Members’ positions in the following sequence:
1) All Opening Buys
2) All Opening Sells
3) All Closing Buys
5) All Closing Sells
Because closing buys are processed before exercises, there is no possibility of assignment on positions that were closed via closing buy orders during that day’s trading hours.
Q: When I sell an option to open, is my only chance of being assigned (and being required to fulfill my obligations as the option writer) when the person or entity that bought from me decides to exercise?
A: No. There are several reasons why this is untrue. First, the buy side of your opening sale could have been a closing purchase by someone who was already short the option. Second, as assignments are handed out randomly, anyone who is short that particular option is at risk of being assigned when an option holder exercises. Third, assuming the other side of your trade was an opening purchase, they may sell to close anytime but since you are still short, you are at risk of being assigned. As long as you keep a short option position open, you are at risk of being assigned. Generally speaking, assignment risk increases as the option becomes deeper in the money and as expiration approaches (the option trades with less time premium). Assignment risk also increases just before the ex-dividend date for short calls and just after the ex-dividend date for short puts.
At expiration all equity options that are in-the-money by a penny or more are exercised unless the option holder instructs their broker not to exercise.
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