Why does assignment notice matter in options trading?

An assignment notice is the formal notification to an options seller (writer) that the option they sold has been exercised by the buyer, obligating the seller to fulfill the terms

An assignment notice is a pivotal communication for anyone who sells options. When an option buyer decides to exercise their right, whether it's to buy shares in the case of a call option or sell shares in the case of a put option, the Options Clearing Corporation (OCC) initiates a process to assign a corresponding seller. The seller who is chosen receives an assignment notice, which is their official notification that they are now obligated to fulfill the terms of the exercised contract. This means if you sold a call option and received an assignment notice, you are required to sell 100 shares of the underlying stock at the strike price to the option buyer. Conversely, if you sold a put option and received an assignment notice, you are obligated to buy 100 shares of the underlying stock at the strike price from the option buyer. The method of assignment for standard equity options is typically random for clearing members, and then clearing members often use their own random or "first-in, first-out" method to assign their customers. This notice fundamentally changes an open options position into a stock position, or cash settlement in some cases for index options, and has immediate financial implications. It's not a voluntary action on the part of the seller; rather, it’s a consequence of having sold the option contract. Understanding the mechanics and implications of an assignment notice is essential for managing risk and making informed decisions when writing options. The timing of an assignment notice often occurs after market close, and the actual settlement of the transaction typically takes place on the next business day (T+1) or two business days (T+2), depending on the underlying asset and option type. Awareness of potential assignment is a key part of an options seller's strategy, especially for options that are deep in-the-money as their expiration approaches.

Why it matters

- An assignment notice directly triggers an obligation for the options seller. It means you are legally required to buy or sell the underlying asset at the strike price, which can result in significant financial consequences if you are not prepared or if the market moves unfavorably.
Ignoring an assignment notice is not an option; it's a binding obligation. Failure to meet this obligation can lead to account deficiencies, margin calls, and potentially severe penalties from your brokerage firm and regulatory bodies.
The receipt of an assignment notice marks the transition from an options position to a stock position. This change in asset type has different risk profiles, margin requirements, and tax implications, requiring an update to your portfolio management strategy.
Understanding the factors that lead to an assignment notice helps in risk management and strategic planning. Knowing when and why options are likely to be exercised allows traders to adjust their positions or close them out before assignment occurs, thus avoiding unwanted obligations.

Common mistakes

- A common mistake is selling options without fully understanding the assignment risk. Many traders focusing solely on premium income overlook the potential for assignment and the obligations it creates, leading to surprise stock ownership or sales that weren't intended.
Another error is failing to monitor in-the-money short options, especially near expiration. Options that are in-the-money by even a small amount have a high probability of being exercised, and thus assigned, often catching unprepared traders off guard.
Traders sometimes assume that options will simply expire worthless if they are only slightly in-the-money, ignoring factors like dividends for call options or specific market events that might prompt early assignment. This oversight can lead to unexpected obligations and forced stock transactions.
Not having sufficient capital or margin to cover the obligations resulting from an assignment notice is a critical mistake. If assigned, you might be required to buy or sell a large quantity of stock, which can exceed your account's capacity and lead to forced liquidation of other assets.

FAQs

What happens immediately after receiving an assignment notice?

Upon receiving an assignment notice, your brokerage account will reflect the obligation. For a short call, you will typically be short 100 shares of stock per contract at the strike price, and for a short put, you will be long 100 shares of stock per contract at the strike price.

Can I prevent an assignment notice once an option is exercised?

Once an option has been exercised by the buyer, you cannot prevent the assignment notice if you are selected. The only way to completely avoid an assignment notice is to close out your short option position before it is exercised or assigned.

Does an assignment notice apply to both call and put options?

Yes, an assignment notice can apply to both call and put options. If you sell (write) a call option and it's exercised, you receive an assignment notice obligating you to sell shares. If you sell (write) a put option and it's exercised, you receive an assignment notice obligating you to buy shares.