What does assignment mean?

Assignment in options trading refers to the obligation of an option seller (writer) to fulfill the terms of the option contract when the buyer chooses to exercise their right.

In the world of financial options, 'assignment' is a critical concept for anyone selling (writing) options contracts. When an option buyer decides to exercise their right to either buy (for a call option) or sell (for a put option) the underlying asset, the option seller is then 'assigned' the obligation to complete that transaction. For instance, if you sell a call option and the buyer exercises it, you are assigned the obligation to sell the underlying shares to them at the agreed-upon strike price. Conversely, if you sell a put option and the buyer exercises it, you are assigned the obligation to buy the underlying shares from them at the strike price. This process typically occurs through the Options Clearing Corporation (OCC), which randomly assigns exercise notices to brokers who then allocate them to their clients who have open short option positions. The likelihood of assignment increases as an option moves further into the money, especially as it approaches expiration. While most options expire worthless, assignment is a very real possibility for in-the-money options. Understanding assignment is crucial because it dictates the obligations and potential financial responsibilities of the option writer, impacting their portfolio management and risk assessment. It's a fundamental mechanism that ensures option contracts are honored and that the buyer's rights are upheld, creating a balanced and functioning options market.

Why it matters

- Understanding assignment is fundamental for option sellers to manage risk. It directly impacts whether they will be required to buy or sell the underlying asset, often at an unfavorable price relative to the current market.
It highlights the potential for significant capital requirements. If assigned, an option seller needs to have the capital or shares available to fulfill the contract, which can have a substantial impact on their trading account.
Knowing about assignment helps traders make informed decisions about holding or closing their short option positions. Traders might choose to close out in-the-money short options before expiration to avoid the uncertainty and obligation of assignment.

Common mistakes

- A common mistake is underestimating the probability of assignment for in-the-money short options, especially close to expiration. Always monitor your short option positions and be aware of their intrinsic value and time until expiry.
Another error is not having sufficient capital or shares to cover a potential assignment. Ensure you maintain adequate margin or own the underlying shares if you are selling covered calls to avoid unexpected financial strain.
Some traders neglect to consider the early assignment risk, particularly for deep in-the-money call options on stocks that are about to pay a dividend. Buyers might exercise early to capture the dividend, assigning the seller the obligation. Always be mindful of ex-dividend dates for underlying stocks.

FAQs

What happens if I get assigned on a call option?

If you are assigned on a call option you sold, you are obligated to sell 100 shares of the underlying stock per contract at the strike price. This usually means you will deliver shares you already own or buy them on the open market at the current price to fulfill the sale.

What happens if I get assigned on a put option?

If you are assigned on a put option you sold, you are obligated to buy 100 shares of the underlying stock per contract at the strike price. This means you will need to have sufficient capital in your account to purchase those shares.

Can I avoid assignment?

You can avoid assignment by closing your short option position before it is exercised. This usually means buying back the option you sold, which will incur a cost but removes the obligation to buy or sell the underlying asset.