Early assignment is a unique characteristic of American-style options, allowing the option buyer to exercise the contract at any point between the purchase date and the expiration date. This differs significantly from European-style options, which can only be exercised at expiration. When an early assignment occurs, the option seller (writer) is obligated to deliver or purchase the underlying asset at the strike price, regardless of the current market price or how much time is left until expiration. For a call option seller, early assignment means delivering shares of the underlying stock at the strike price. For a put option seller, it means purchasing shares of the underlying stock at the strike price.
Several factors can lead to early assignment. For call options, a common reason is when the underlying stock goes ex-dividend. If a call option is deep in-the-money and the dividend payment is substantial, the option holder might exercise early to capture the dividend. For put options, early assignment can occur if the stock price drops significantly below the strike price, and interest rates are high, making it costly for the option holder to maintain the position without exercising. However, for both calls and puts, early assignment is generally not economically optimal for the option buyer if there is still significant time value remaining in the option, as exercising early forfeits this time value. Therefore, early assignments are more common for options that are deep in-the-money and have very little time value left, or when specific corporate actions, like dividends, make it financially beneficial for the option holder to take ownership of the underlying shares.
Option sellers need to be aware of the potential for early assignment, as it can occur unexpectedly and impact their portfolio. Managing assignment risk often involves understanding the characteristics of American-style options and the factors that motivate early exercise. While many options expire worthless or are closed out before expiration, the possibility of early assignment always exists for American-style options writers.
Only American-style options are subject to early assignment, allowing the holder to exercise the option at any time before its expiration date. European-style options can only be exercised on their expiration date.
An option holder might choose early assignment to capture an upcoming dividend on the underlying stock (for call options) or if the option is deep in-the-money with very little time value remaining, and holding the position further offers no significant advantage.
When early assignment occurs, the option writer is obligated to fulfill the terms of the contract. For a call writer, they must sell the underlying shares at the strike price, and for a put writer, they must buy the underlying shares at the strike price.
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