What does assignment notice mean in option trading?

An assignment notice is a formal notification to an option seller that the option they sold has been exercised by its holder, obligating the seller to fulfill their end of the cont

An assignment notice is a critical event for anyone who sells options, whether they are writing calls or puts. When an option buyer decides to exercise their right, the Options Clearing Corporation (OCC) initiates a process to randomly select a seller of that specific option contract to fulfill the obligation. This seller then receives an assignment notice, which informs them that they must deliver on the terms of the exercised contract. For a call option seller, receiving an assignment notice means they are obligated to sell 100 shares of the underlying stock at the strike price, regardless of the current market price. If they don't already own the shares, they will need to buy them at the market price to fulfill their obligation, potentially incurring a significant loss. Conversely, for a put option seller, an assignment notice obligates them to buy 100 shares of the underlying stock at the strike price. This could lead to a loss if the market price of the stock is lower than the strike price at which they are forced to buy. The assignment process is typically random among all brokerage accounts holding short positions in the exercised series, making it unpredictable for individual traders. Upon receiving an assignment notice, the brokerage firm will typically alert the client, and the trade necessary to fulfill the obligation will be executed, usually on the next business day. Understanding the implications of an assignment notice is crucial for option sellers as it represents the point at which their open short option position becomes a concrete financial transaction, determining profits or losses.

Why it matters

- Understanding assignment notice is crucial for option sellers because it signifies the point where a theoretical obligation becomes a real financial transaction. It dictates whether you must buy or sell the underlying asset at the strike price, impacting your potential profit or loss.
It highlights the risks associated with selling options, particularly naked options, as the capital required to fulfill the assignment obligation can be substantial, especially if the market moves unexpectedly against your position.
Being aware of assignment notice helps traders manage their positions effectively. Knowing the implications allows for proactive risk management strategies, such as closing out short positions before expiration or rolling them to avoid assignment.

Common mistakes

- A common mistake is ignoring the potential for early assignment, particularly with in-the-money call options on stocks that are about to go ex-dividend. Traders might assume assignment only happens at expiration, leading to unexpected obligation.
Another error is failing to maintain sufficient margin in the account to cover potential assignment. If an option is assigned and the trader lacks the necessary capital or shares, it can lead to forced liquidation of other positions or margin calls.
Traders sometimes overlook the costs associated with assignment, such as transaction fees and the potential for significant losses if the market price of the underlying asset moves sharply against their assigned position. Always factor these into your potential risk.
A frequent oversight is not understanding the random nature of assignment. While an option may be deep in-the-money, there's no guarantee that a specific short contract will be assigned until an assignment notice is received.

FAQs

Who sends an assignment notice?

The Options Clearing Corporation (OCC) handles the assignment process. They allocate exercises to clearing firms, who then randomly select client accounts holding short positions to receive the assignment notice.

What happens after I receive an assignment notice?

Upon receiving an assignment notice, your brokerage firm will inform you and execute the required transaction. For a short call, you'll sell shares; for a short put, you'll buy shares, all at the option's strike price.

Can I avoid an assignment notice?

Yes, you can generally avoid receiving an assignment notice by closing out your short option position before it is exercised. This usually means buying back the option you sold in the open market.