Tag Archives | exercise and assignment

Exercise and Assignment. Not to worry

The exercise/assignment process is straightforward, easy to understand, and is experienced by almost every option trader at one time or another. 

An option is a contract in which the writer (seller) promises that any buyer has the right  to buy or sell the underlying asset at the strike price on or before a specific date.

Electing to buy or sell the underlying (per the contract) is referred to as 'exercising.'  Being notified that the exercise has been assigned to your account is referred to as an 'assignment.'

Unfortunately, many new traders become overly worried about the process because they  don't bother to pay attention to the rules regarding how the process works. Why would anyone trade an option without being aware that it's possible to be assigned early?  When we drive a car, we are supposed to learn the rules of the road.  Traders who don't take the time to understand what they are trading are flying blind.

I've discussed this topic many times (here's the first), and you can search (below) for Exercise and assignment to read some of the posts.


Free put, free call

Why beginner's fear being assigned an exercise notice is beyond my comprehension.   When anyone sells an option, he/she is accepting an obligation to be assigned.  So why is it it so unsettling to be assigned one of those exercise notices prior to expiration?

Being assigned an exercise notice turns a short call option into short stock.  So what?  That exercise is equivalent to giving the option seller a free put [same strike and same expiration as the option being assigned].

Being assigned an exercise notice on a put option does cost a bit of cash (in carrying costs), but it is equivalent to being given a free call.

It's unlikely that these free options will be worth anything, but every once in awhile lightning strikes and I love  being handed those free puts and calls.  Unless it results in a margin call, being assigned early is not a problem.  If it does result in a margin call, you are probably trading too many contracts for the size of your account.

 

European and American style options

European style options cannot be exercised prior to expiration.  If you absolutely cannot tolerate being assigned early, it may pay to trade European style options.  However, there are far more important items that differ between American and European style options that it's crucial to understand these differences before attempting to trade them.  this is not an idle warning.

To read more about these differences, search (below) for American vs. European options

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