How assignment risk affects options prices

Assignment risk refers to the possibility that an options contract you have sold will be exercised by the buyer before its expiration date, forcing you to either buy or sell the un

Assignment risk is a significant consideration for options sellers, particularly for those who write call or put options. When you sell an options contract, you are obligating yourself to either buy (for a put option) or sell (for a call option) the underlying asset if the buyer decides to exercise their option. This obligation can become a risk when the underlying asset's price moves favorably for the option buyer, making early exercise a profitable decision for them. For instance, if you sell a call option and the stock price rises significantly above the strike price, the call buyer might exercise early to capture gains, forcing you to sell shares at a lower strike price. Conversely, if you sell a put option and the stock price drops well below the strike price, the put buyer might exercise early, obligating you to buy shares at a higher strike price. The closer an option is to being in-the-money, and especially if it is deep in-the-money, the higher the assignment risk. Additionally, options on stocks that pay dividends often see increased early assignment risk just before the ex-dividend date, as the buyer may exercise to receive the dividend. Managing assignment risk involves careful monitoring of the underlying asset's price, understanding your obligations, and potentially adjusting your position, such as by rolling or closing the option, to avoid involuntary assignment.

Why it matters

- Understanding assignment risk is crucial for options sellers because it directly impacts potential financial obligations and unexpected capital requirements. Being assigned means you must fulfill your end of the contract, which could tie up capital or force unwanted transactions.
This risk plays a key role in pricing options, as market makers and traders factor in the probability of early exercise. Options with higher assignment risk may trade at different premiums to compensate sellers for this increased possibility.
Awareness of assignment risk helps traders make informed decisions about strike prices, expiration dates, and when to close or roll positions. It's a fundamental aspect of managing the liabilities associated with selling options.

Common mistakes

- A common mistake is underestimating the likelihood of early assignment, especially for deep in-the-money options or those nearing an ex-dividend date. Always monitor these conditions carefully to anticipate potential exercise.
Another error is failing to have sufficient capital or the underlying shares available to cover the assignment. This can lead to forced borrowing or unexpected transactions, incurring additional costs or losses.
Traders sometimes neglect to consider the impact of time value decay on early exercise. While deep in-the-money options have less time value, any remaining time value discourages early exercise unless there's a dividend incentive. Assuming early assignment won't happen because of small remaining time value can be a misjudgment.

FAQs

What typically increases assignment risk?

Assignment risk generally increases when an option is deep in-the-money, meaning the underlying asset's price is significantly past the strike price. It also rises sharply just before the ex-dividend date for call options, as buyers might exercise to capture the dividend.

Can I prevent assignment risk?

You cannot completely prevent assignment risk as long as you are short an options contract. However, you can manage it by closing your short option position, rolling it to a different strike or expiration, or ensuring you have the necessary capital or underlying shares to meet your obligations.

How does early assignment affect options traders?

Early assignment forces the options seller to buy or sell the underlying asset at the strike price, potentially before they intended. This can lead to unexpected capital requirements, an involuntary change in portfolio position, or even losses if the market moves unfavorably after assignment.