An Early Christmas Present: Being Assigned an Exercise Notice

One of the characteristics that describes being a rookie (at anything) is the anticipation – more accurately, the concern – that something unexpected will happen and that whatever it is, it's going to be bad news. 

The rookie often worries about, or anticipates, problems that don't exist.  Don't misunderstand.  It's fine to think about potential problems and know how to deal with any that may arise.  That's a significant part of the learning process.

The problem (as I see it) is that being reassured that 'it' is not a problem is often insufficient to alleviate those concerns

Case in point:  Early exercise.

Based on the questions I receive, one
of the topics that seems to be of major concern to the rookie option
trader is the possibility of receiving an assignment notice prior to
expiration.  I always reply that it's nothing that need concern you –
unless it triggers a margin call from your broker. 

Another example:

visiting online forums, I sometimes run into people who have another
misconception: that it's impossible to be assigned an exercise notice
on an option that is out of the money
.  I have no idea why anyone would
believe that.  An option owner has the right to exercise at any time, for any reason, prior to expiration.  I'm not suggesting that anyone ought to expect to receive an assignment notice on such OTM options, but the possibility exists.

This morning (Dec 16), a friend of mine had an interesting experience  and I want to share it with you.  More than that, this is a real-life situation that may alleviate some of the concerns that trouble rookies.

He had sold 10 KR (Kroger) Dec 20 puts and to eliminate all risk, was bidding $0.05 to cover the short position.

The previous day's closing price was $20.16, and his bid for the puts went unfilled.

This morning, he received an exercise notice on FOUR of these OUT OF THE MONEY puts.  

My friend received an early holiday gift.  Not only did he not have to pay the nickel to cover his short puts, but he was paid an extra premium for closing the position!   By selling 400 shares at the opening of trading today, he collected extra cash ($17 for each of the four options).  Sure, he had to pay a commission – but it was well worth it.  

Too bad it was only a four-lot, but no one is complaining.  Except for the investor who exercised those options. 

I'd love to have the ability to find that investor and ask why the options were exercised.  But that's impossible. 

I have a theory:

The investor's broker alerted him/her to the fact that the position was in the account and would soon expire (probably resulting in a margin call, if exercised).  That inexperienced trader took that 'alert' as a warning to exit the position.  And, as too many innocent option rookies do, had no idea that selling the puts was the correct path. 

Not knowing what else to do, perhaps our novice exercised the options to get rid of the puts.  That would be a shame and a costly experience, but it's the best rationale I have for the exercise.


6 Responses to An Early Christmas Present: Being Assigned an Exercise Notice

  1. Jesse 12/17/2009 at 6:42 AM #

    Once again the trading adage: the market is uncertain and anything can happen. Your friend is really lucky to have such an early Christmas gift. How I admire him! Merry Christmas to all.

  2. John Doe 12/17/2009 at 3:59 PM #

    A better Christmas gift was the 22k I made today when my CTM (1055-1075 / 1125-1145) SPX IC expired OTM!

  3. Mark Wolfinger 12/17/2009 at 4:12 PM #

    I published a reply, then withdrew it.
    This is a very serious situation – and demands it”s own post.
    For now let me assure you that your SPX options have NOT expired and they are still CTM options.
    How is it possible that you don’t know that?

  4. John Doe 12/17/2009 at 4:14 PM #

    You’re correct. Technically, closes at the opening print tomorrow morning for all component stocks.

  5. John Doe 12/17/2009 at 4:30 PM #

    Quick reply on your part as well!
    I might have closed this position down early, but I typically hold through expiration. We’ve been stuck between 1085-1115 for the past month and I did not, nor do I foresee anything ‘kicking’ us out of that range for a while. Probably won’t see any more serious (directional) movement until Q1 earnings come out.
    This month, I am CTM than I would normally like, but IV > premiums were low this month, and rightfully so!
    I prefer CTM spreads because of the higher premiums. I’ve got a sizable LONG portfolio that is in addition to my ‘speculative’ option trading portfolio, which hedges my upside risk some. As you might surmise I do a great deal of position sizing and risk management.

  6. Mark Wolfinger 12/17/2009 at 4:51 PM #

    I certainly feel much better knowing that you understand what you are doing.
    You don’t see the game as I see it. I get messages from people who buy and sell options with no idea of the rules of the game. I thought your trade was rather big size for someone who did not know the options were alive overnight.
    Glad you have you head is on straight. I’ll ask you to forgive me because I already wrote and scheduled an angry reply to your original post.
    I am not necessarily angry with you – but at the whole industry that allows people to play the game – and has no concern for their welfare. There is no requirement that someone demonstrate knowledge of the rules before being allowed to play.
    Thanks for sharing the additional information. I truly feel much better.