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

  • Important Tips For First Time Currency Traders

    Diversifying your portfolio is important for all investors, and currency investments are a great way to do that. However, there are a lot of misconceptions and common mistakes that first time currency investors make, and this leads to big losses.

    By Kim,

    • 0 comments
    • 75 views
  • Iron Condors or Short Strangles?

    In my early option trading days, I favored selling iron condors over selling strangles. I thought that selling a strangle was too risky because the potential loss was “undefined”. I thought this made sense because this is what I’d hear from other people that were more experienced than I was.

    By Jesse,

    • 0 comments
    • 1,201 views
  • How To Be A Successful Day Trader From Home

    The good news is that if trading is your passion, then it’s possible to become a successful day trader and work from home. However, it’s not as easy as setting up shop and jumping online. There are specific steps and processes you need to have in place if you’re going to be able to make a living for yourself and have a bright career and future.

    By Kim,

    • 0 comments
    • 154 views
  • 3 Key Pieces Of Advice For New Traders

    These days, everyone claims to be an ‘expert’ on absolutely everything. Apparently, it only takes having a Twitter account to be a seasoned expert on any given subject; all in all, the Internet is full of nonsense. It’s becoming harder and harder to find legitimate answers amongst the quagmire of false information online.

    By Kim,

    • 0 comments
    • 216 views
  • Why New Traders Fail

    Our first advice to new traders is: "Learn First, Trade Later". The markets will always be there, but if you start trading without proper fundamentals, your capital will be gone very fast. The barrier to enter trading is so low today, commissions are near zero, and the whole trading game looks very promising.

    By Kim,

    • 0 comments
    • 411 views
  • Lumpy Dividends and Options

    Dividend payments, like oatmeal, may be smooth or lumpy. Smooth dividends are predictable, usually once per quarter. It is easy for options traders to believe these dividends are guaranteed, because they usually continue uninterrupted quarter after quarter. This also makes it easy to predict total return over a longer time span.

    By Michael C. Thomsett,

    • 0 comments
    • 384 views
  • Coming to Peace With Market Volatility: Part II

    On April 18th I wrote part I of this article, Coming to Peace With Market Volatility. I showed how the US equity market risk premium, defined as the annual average return of the Total Market minus the return of one-month US Treasury Bills, was a large 8.37% per year from 1950-2019. That’s the good news.

    By Jesse,

    • 0 comments
    • 421 views
  • Ratio Calendar Spreads

    The ratio calendar spread is well-known to some, but for others the risk/reward aspects are not well understood. One way to cover a short position is to own 100 shares of the underlying stock. Another, more creative way is to sell a shorter-term expiration position and buy a longer-term position.

    By Michael C. Thomsett,

    • 0 comments
    • 831 views
  • Studies Vs. Real Trading

    "Who you gonna believe, me or your lying eyes?" Our members and readers know that buying pre earnings straddles has been one of our favorite strategies that produced consistent gains in the last 8 years with very low risk. Yet there is a significant number of studies showing that this strategy has a negative expectation. 

    By Kim,

    • 0 comments
    • 776 views
  • Should You Hedge or Diversify?

    Using the most popular S&P 500 ETF (SPY) to represent the US stock market, this article will look at different ways to manage equity market risk using historical ETF and options data from ORATS Wheel since 2007. We will analyze the following unhedged, hedged and allocation choices:

    By Jesse,

    • 11 comments
    • 1,149 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


Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido