Option assignment happens when the owner of an options contract elects to exercise their puts or calls. That means they wish to trade the underlying security at the strike price which requires the options contract seller to fulfill their obligation.
While relatively few options contracts are ever exercised, options writers must be aware of assignment risk. Options assignment requires buying or selling the underlying security at the strike price.
As with all options trading, it’s important to know and understand all the key risks. American-style options can be exercised at any time before expiration, which means sellers might be faced with option assignment whenever they hold a short position. Option assignment is also more likely as expiration nears.
What Is Option Assignment?
Writers/sellers of option contracts assume the obligation to buy or sell shares to satisfy the terms of the options contract. Buyers/holders of options contracts purchase the option to exercise these options under the terms of the options contract.
Option assignment is the process of matching an exercised option with a writer of an option. In the rules laid out in a basic options trading guide, the individual short an options contract is obligated to fulfill their duty by either purchasing or selling a specific number of shares of the underlying stock should the holder choose to exercise their option.
The option contract owner, also called a holder, has the right but not the obligation to buy (in the case of a call option) or sell (in the case of a put) a predetermined number of shares at a strike price. It is only when the option contract holder elects to exercise, that option assignment happens. The individual short the options must then abide by the contract’s provisions.
How Does Option Assignment Work?
Option assignment works when the seller completes the terms outlined in an options contract after the call or put contract owner chooses to exercise. By selling an option, you issue the buyer the right to own a certain number of shares of stock at a predetermined price in the future. Any option strategy that has a short leg, such as a bull put credit spread, has assignment risk.
Call options offer the owner the right but not the obligation to buy stock while put options give the holder the right but not the obligation to sell shares. The call option seller, on the other hand, would potentially be required to buy stock in order to sell it to the call option owner.
Writers of bond options also face assignment risk.
A Peek Under the Hood
The mechanics of this process can seem unclear since there are so many options contracts traded, and it’s hard to determine who is on the other side of your trade.
Options trade through exchanges, and since they are standardized contracts, the exchange is essentially the counterparty. The entity in charge of facilitating exercises and assignments in the U.S. is the Options Clearing Corporation (OCC). Option assignment rules are followed, and the OCC ensures a fair process.
An options assignment happens when the holder exercises a contract. The OCC then randomly allocates this assignment to brokerage firms that have account holders who are short that contract. The brokerage firms then use their own rules and processes to allocate the assignment to a specific holder.
The two parties to the assignment are not required to be the same two parties that entered into the original options contract.
Can You Know If a Position Will Be Assigned?
According to the Options Industry Council (OIC), it’s hard to know when you will be assigned, as it can happen any time up to expiration for American-style options. Many index options, or index futures options, are European-style however.
It may be helpful to know that just 7% of option holders exercise their right, and that percentage has not budged much over the years, according to the OIC.
Can You Do Anything If a Position Is Assigned?
You must meet your option assignment duties once you are assigned. What’s nice, though, is that many brokers handle the process automatically for you. Traders should be prepared to see their account balances fluctuate when an assignment happens. When trading futures options, you might also see a cost of carry with the underlying futures contracts.
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What Happens After a Position Is Assigned?
A writer facing an options assignment will be notified through their brokerage firm.
A seller of call options must deliver shares at the strike price and in return receives cash. If the seller wrote covered calls — and therefore owns the shares in their account — their brokerage can simply transfer the shares from one account to the other, and the seller will receive the strike price for each sold share.
If the seller sold naked calls, they will be required to buy shares on the open market to provide them to the options holder, but will also receive the strike price per share. If the seller has pursued a combination options strategy, it might be possible to exercise another option to satisfy the terms of the assigned option.
For someone short puts facing option assignment, they are obligated to buy shares at the exercise price from the holder of the option. If the put seller pursued a cash secured put strategy, they will have the cash in their account to make the purchase. If the seller does not have the cash, they will have to deposit sufficient funds or sell account assets to fund the obligatory assignment purchase.
Option Assignment Example
It helps to run through an options assignment example to grasp how the process works.
Let’s say you were bearish or neutral on the price of XYZ stock over the coming 30 days. You also want to take advantage of what you believe to be high implied volatility of call options on that stock.
After analyzing the option Greeks, you decide to sell $100 strike call options while the shares trade at $95. The option premium you collect is $10.
After three weeks, the stock has jumped to $105, and the short calls are worth $6. You are alerted that you now face a call option assignment. While a small percentage of options contracts are exercised, you are among the few who are chosen to be assigned.
To meet the requirements of option assignment, you must deliver shares to the individual who exercised the call option. You can buy shares in the market or, if you own shares and wrote a covered call, your shares might be called away.
For puts, the purchaser of the option sells (or “puts”) shares to the writer by way of a short position.
Option Assignment and Multi-Leg Strategies
Some of the more complex options trading strategies, like those involving many legs, can face more option assignment risks. If just one leg of a broader trade is assigned, the writer must act. That might involve closing the entire strategy or simply adjusting the other legs to manage risk.
Once an option seller’s position is assigned, the trader must meet the contract’s terms to buy or sell shares of the underlying security, regardless of what other legs the writer has active. That is part of the risk of selling options as part of a multi-leg strategy.
What Does Assignment Mean for Individual Investors?
Options assignment is just another risk to be mindful of when selling puts and calls. While there are plenty of upshots to writing options, such as collecting premium, assignment risk is present. It’s important that you check with your brokerage firm to know their option assignment process and cut-off times. Some firms might have significant costs while others might feature option assignment free trading.
Option assignment happens to writers of contracts when the owner of puts or calls elects to exercise their right. Options sellers are then required to purchase or deliver shares to the individual exercising. The OCC randomly selects sellers through the option assignment process.
Only option sellers face assignment risk, so you can avoid the risk by only being on the long side of contracts.
If you’re ready to try your hand at trading options online, you can set up an Active Invest account and trade trade options from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, however other fees do apply, and members have access to complimentary financial advice from a professional.
How is option assignment determined?
Option assignment is determined by the OCC which randomly assigns firms that have accounts short options. This only happens once an options contract holder chooses to exercise. While a small portion of options contracts are exercised, traders should understand the risks, particularly as expiration nears, as that is when assignments are more likely.
Are options assigned before or after expiration?
American-style options can be exercised, and thus assigned, any time before expiration. European-style options, however, are only allowed to be exercised during a specific period right before expiration, so options assignment can only happen then. Be sure to know the style of options contract you are selling so that you know your option assignment risk.
What are option assignment fees and how much are they?
Options assignment fees vary by brokerage. These days, trading commissions to fulfill obligations from being short an options contract are generally reasonable. There could be a base options trading fee plus a per contract charge, but some brokers do not have options assignment fees at all.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.