SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Fear of Options Assignment


One of the most common fears in option trading is one of early assignment.  The fear of having a large number of shares (or a large short position) coupled with a potential margin call (or Reg-T call) causing a sudden shortage of cash in their accounts worries investors.  Investors commonly view assignment as a huge potential risk.

It is not. (Well, it is rarely a problem).  In fact, almost 99% of the time, early assignment is a better outcome.  Below will set forth two common assignment examples, work through the potential outcomes, and demonstrate why assignment is typically a better outcome than having just held the position.

 

For Steady Option’s Anchor members, there is a persistent risk of being assigned a long stock position on the income producing portion of the strategy (the short SPY puts).  This only happens in sharp market declines or very close to rolling of the position, but it can happen.  Assignment risks increases the closer the position gets to a delta of 1.  Most recently, this happened the week of May 13, 2019.For purposes of this example, we’ll use the actual SPY positions and walk through what did occur and could have occurred in other possible market situation. 

 

In early May, the strategy sold four contracts of the May 20, 293 put for $3.11.  The market started to drop. On May 19, 2019, the options were early exercised when SPY hit 285.  The value of the contract when assigned was $8.11.  All of a sudden, most accounts had 400 shares of SPY and were down $117,200 (4 contracts x 100 x $293).  Most accounts don’t have cash in them to cover the position and may have received a Reg-T notice (a Reg-T notice is a form of a margin call by your broker).   What is a trader to do?

 

Well first, the next trading day, simply close the position.  Sell the stock, and the margin call should be covered.  If it’s not, you can always sell other holdings to cover it.  The way the Anchor Strategy is structured, it is virtually impossible not to have available cash or stock to cover in this situation.  After closing the assigned position, is the trader worse or better off than if the position had been held?  In all market conditions (up, down, flat), the trader is either in the same position as not having been assigned or better off.

 

Note: This assumption ignores transaction costs.  Some accounts have assignment fees, different commissions for buying and selling stocks and options and other various fees.  These fees could make a difference on the analysis, depending on a trader’s individual account.  Since such fees vary widely, the below discussion ignores all fees.

               

The Market stays flat, SPY stays right at 285
 

In this case, the trader sells the assigned shares back at $285, facing a loss of $8.00/share.  ($293 - $285)[1].    In other words, the trader has lost $1,956 ($8 stock loss less $3.11 received for selling the original position). This seems like a poor outcome.

[1] For purposes of this article, I am going to ignore the fact that the position was hedged and look at it just from the assignment point of view. 
 

However, this is better than if the trader had just closed the short put at $8.11 at the market open.  In that case, the trader would have lost $2,000.  (($8.11 - $3.11) x 4 x 100).  By being early assigned, the trader saved $0.11/share.  This is what actually happened in actual trading the week of May 13.

 

The Market moves up the next morning


What would have happened though if the market had gone up?  Let’s say to SPY $288.  In this case, instead of selling the stock back at $285, you would sell it back at $288.  That is a loss of $5 per share ($293 - $288) for a total loss of $756 on the trade ($5 - $3.11).

 

Once again, the trader is better off.  Delta of the short put is not one, rather it had a dynamic average of .95.  This means the value of the put would have declined not to $5.11 (the previous price of $8.11 - $5.11), but, by $2.85 to $5.26.  Closing that option position would result in a loss of $860 on the trade ($5.26-$3.11).

 

The Market goes down


The scariest situation for a trader is waking up the next morning and the market has declined.  Instead of SPY $285, the market might have continued to go down to SPY $282 (or worse).  In this case, the trader sells the stock for $282, resulting in a loss of $11 per share for a total loss on the trade of $3,156 ($11-$3.11).

 

Yet again, the trader is better off.  With the market going down from $285 to $282, the dynamic delta average is .98 and time value has dropped a bit, and the short put is now worth $11.03.  Closing this put for a loss of $11.03 results in a total loss on the trade of $3,168.  Even if the market had plunged down to SPY 100, the two positions would have been equivalent – meaning that the loss by being assigned equals the loss of having been in the short put.

 

In other words, in every market situation, the trader is either better off or exactly the same when assigned the position rather than having simply held the short put.  The closer delta is to 1, the more likely you are to be assigned, but even in that situation, you would be no worse off between assignment and holding.

 

But if that’s true for puts, is it also true for calls?


Let’s take a common example.  You sell 5 contracts of the $100 call on Stock ABC that is currently trading at $99 for $2.00.  You are now short the $100 call.  You receive $1,000.  It expires in 3 weeks.  Two weeks from now the stock is trading at $99.80 with earnings coming up tomorrow, and the option is trading at $1.00.You have $1,000 in cash and -$500 in call value.  Someone exercises the option.  The next morning your account looks like:

  • Short 500 shares ABC at a value of $49,900
  • Long $51,000 cash ($50,000 for sale of stock at $100/share plus $1,000 from the sale)

               

Are you in trouble?  Did you lose money?  Once again no, you’re not. Let’s look at what happens in each situation at market open:

 

The Market stays flat at $99.80


In this situation, you buy back the 500 shares of Stock ABC for $49,900.  You keep the $51,000 and did not have to buy back the call.  So you’re up $1,1000.
 

If you had not closed the position out, not been assigned, and the market stayed flat, the price of the option may have declined to around $0.50. 


Clearly, you are better off because of the assignment – by over $800.

 

The Market goes down (any amount)


Earnings come out and the price drops to $90 (or any value below $100).  In this situation, you buy back the 500 shares for $45,000.  You keep the $51,000 and did not have to buy back the call.  So you’re up $6,000.
 

If you had not closed the position out, not been assigned, and the market went down, the price of the option may have declined to $0.01.
 

Again, you are better off because of the assignment – by almost $6,000.


The Market goes up by less than $2 (to under $102)


Earnings come out, and the price increases to $102 (or anything between the last close and $102).  You buy back the shares for $51,000.  This nets out the cash you already had and did not have to buy back the calls.  In this situation you break even.


If you had not closed the position out, not been assigned, and the market went up, the price of the option contract would have increased to at least $2.00. 


In this case, you are in the same boat because of the assignment.  Closing the short contract at $2.00 would cost you $1,000, which nets to $0.00 with the $1,000 you received from the sale.

 

The Market goes up by more than $2 (e.g. $110)


Earnings come out, and the price increases to $110.  In this situation you must buy the shares back for $55,000.  Offsetting with the cash already received, you have lost $4,000.


If you had not closed the position out, not been assigned, and the market went up a significant amount, the option price would have increased to at least $10.  Closing this short contract out will cost $5,000. You are again better off because of the assignment.


In other words, in every situation you are in an equal or better situation because of an assignment.  This is because options have time value – which an early assignment forfeits to the option contract holder.  Even if the option contract had no time value left in it, the worst situation is still break even.


The only real risk to assignment is failing to quickly move and adjust the position (eliminate the over sized short position), your account goes into a Reg-T call, and your broker starts closing positions in a non-efficient manner.There are brokers who also require margin calls to be covered by cash deposits, instead of adjusting positions.  (Very few).  If that’s the case, you may get a demand for cash (and switch brokers). 

 

As long as you stay on top of your positions and address any assignments, there is no reason to fear early assignment since in all situations you will be either equal or better off on early assignments.  This is why I am almost always surprised by early assignments.  The only time early assignment really ever makes sense is on surprise dividend announcements that weren’t originally calculated into the option prices – and even then, as the price of the option likely moved before the assignment occurred, there may be no impact.

 

What any option investor should always keep in mind is what to do if they get assigned early, what that will look like, and what trades will need to be entered the next business day.  Being prepared prevents fear and mistakes – particularly when there is no need for that fear in the first place.

               

Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Strategy and and Lorintine CapitalBlog.
 

Related articles

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Building a Short Strangles Portfolio

    In my last article I showed you what you can expect selling short strangles and straddles and how much leverage is appropriate. Today I want to show you how to build a well diversified short strangle/straddle portfolio and how to trade it through difficult times.

    By Stephan Haller,

    • 7 comments
    • 246 views
  • Selling Short Strangles and Straddles - Does it Work?

    I have seen a lot of discussions on Twitter lately about the issue if selling naked strangles or straddles is a great strategy or a recipe for disaster. If you have read my books or if you are following my sample portfolio, you know that I'm a huge fan of selling short strangles and straddles.

    By Stephan Haller,

    • 46 comments
    • 802 views
  • Who Wants The Last Nickel?

    “The safest way to double your money is to fold it over and put it in your pocket.” Kin Hubbard. In this article I will discuss the reasoning behind buying back the short options and not waiting till expiration. Two of my basic trading tenets are related:   

    By Mark Wolfinger,

    • 0 comments
    • 39 views
  • Debunking the "Trading Options for Income" Myth

    "Real trading system returns are too irregular in the short term for consistent weekly returns every time and the only 'trader' that every had regular monthly returns was Bernie Madoff" - Steve Burns. So true. This is why "trading options for income" promoted by some options "gurus" is so misleading.

    By Kim,

    • 0 comments
    • 337 views
  • Selling Naked Strangles: The Math

    Selling short (naked) strangles is heavily promoted by some options "gurus". Is it a good strategy? It might have an unlimited (theoretical) risk, but what about the return? Is the return worth the risk? We decided to do some math, based on real prices, not some theoretical "studies".

    By Kim,

    • 6 comments
    • 534 views
  • Don’t Buy Thanksgiving Turkeys as Investments

    Nassim Taleb tells a great story about Thanksgiving turkey’s in his 2007 book, The Black Swan. "Consider a turkey that is fed every day…Every single feeding will firm up the bird's belief that it is the general rule of life to be fed every day by friendly members of the human race 'looking out for its best interests,' as a politician would say.

    By Jesse,

    • 0 comments
    • 144 views
  • Obey Reality and Win by Not Losing

    “I’ll do anything to lose weight (except diet and exercise),” is the same kind of magical thinking by investors who will do anything to outperform the market except study and practice discipline. It takes novice investors about a year to realize that you can’t consistently beat or time the market buying individual stocks or funds.

    By Kim,

    • 0 comments
    • 164 views
  • Follow Your Plan: Don’t Engage in Reckless Trading

    Setting up some internal rules for your trading looks like a must first-step before setting up your account and getting into your platform. You need to get your own trading plan and then stick to it. Self-discipline and avoiding recklessness can be huge for your balance.

    By Kim,

    • 0 comments
    • 231 views
  • 4 Patterns For Forex Profitability

    What makes a forex trader profitable? Looking at a wide array of real data, four patterns are found. Timing is critical. The best time to trade is not necessarily what you thought it would be, and it certainly depends on the trading style.

    By Kim,

    • 0 comments
    • 276 views
  • Long and Short Straddles: Opposite Structures

    Simplification: We can all better understand options trading by removing the complexity so often seen in articles. One of the best ways to understand the profit potential and risk levels of any options strategy is through diagrams and a demonstration of the formula.

    By Michael C. Thomsett,

    • 0 comments
    • 321 views

  Report Article

We want to hear from you!


I dont disagree with what is said but regarding the SPY I made an interesting observation with regard to put positions. Check out this list with open interest of one of the shorter term SPY puts JUN14:

image.png

The Jun19 is the same - as a rough  rule of thumb I noticed that if your short put is 10pts ITM with a week or less to go it tends to get assigned. Hence the zero OI.

Share this comment


Link to comment
Share on other sites


Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs