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The Fungible Option

Hi Mark,

I have a quick question. Let say I sold a put. If the put owner
has sold to close, does it mean my position will never get assigned?

How do I know whether the put owner has or has not sold to close?

Thanks,
John

***

John, this is a good question.  It's one of those things that's impossible to know until you read about it somewhere or ask the question.

1) No.  You can still be assigned an exercise notice

2) You don't have to know

Someone owns that contract and has the right to exercise. You don't have to know who owns that put option.  As long as someone owns it, it may be exercised. 

The only way you can be certain that you are never assigned occurs after you 'buy to close.'


But there's more.  Once you sell your contract – you are 100% separated from the buyer.  Each (for example) SPY Mar 90) put is identical to every other SPY Mar 90 Put.  That means the options are fungible, or interchangeable.

If one, or any other quantity, of those puts is exercised, the the Options Clearing Corporation (OCC) takes over the process. They verify that the person who tells his/her broker to exercise the option actually owns the option and has the right to exercise. 

Next they have a computerized list of every broker and cleaning member who has any customer with a short position in that option.  The OCC employs a random process that chooses one of those brokers and assigns the exercise notice to the broker.

Each broker has a method (that method must be a random selection process or 'first in; first out'.  The latter means the person who has been short the longest is chosen) by which it finds all the customers who have a short position (sold and not yet repurchased or assigned) in that option.  The broker then uses its method – usually random selection – to choose one account.  The broker then assigns the exercise notice to that account.

There's is a bunch of random selection involved in the process.  But the bottom line for you is that it doesn't matter who holds your specific option.  There is always a chance that you will be assigned an exercise notice when anyone, who owns one or more of that specific option, chooses to exercise.

There is no escape.  The option is a legal contract, and as long as you do not cancel your obligation (by buying to close), that contract is in effect until it is assigned or expires worthless.

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Today is George Washington's birthday.  Although no longer a national holiday (it's combined with Abraham Lincoln's birthday (Feb 12) into President's day), it's a good day to celebrate by latching on to this unsolicited testimonial from Ken, and getting a copy of my book:

"I want to thank you so very much for writing your wonderful introduction to
options. It's by far the best source of useful information at my level that I have read. It explicitly addresses so many
questions that other, more technical works take for granted."

TRGFCover 

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