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.
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.