Why Was I Assigned on My Options?

05/05/2010 12:01 am EST

Focus: OPTIONS

In my most recent option class in Milwaukee, Wisconsin, I was asked a very specific question by one of the students. He was assigned on the sold option even though on the April's expiry that Friday, the position, technically speaking, should not have been assigned to him. He asked me the same question that he has asked his broker: "Why was I assigned?"

After obtaining the specifics, I proceeded with my scrutiny of what has really taken place. Here are the facts that he was able to provide to me. He traded an “optionable” stock that was, in the "good old days," trading at the $40 to $50 level. Since then, it came crashing down to below five dollars per share. The options were still listed on it, yet the strike choices given were in the 2.50 increments. There were only a few strike prices listed on that particular asset. Namely, they were 2.50, 5, 7.50, and 10. Technically speaking, the stock was in a strong downtrend, and the student has forecasted that the asset is coming into support, so he was willing to own it.

Rather than purchasing the stock outright, he has chosen to sell a cash-secured put in order to acquire the stock at the discount. At the time, the stock was trading around $3.20, and he was able to sell the April 2.50 put for a juicy premium. Once again, he was bullish on the stock for it was basing or consolidating around that zone between 3 and 2.50 at the time of his entry.

On the April's expiry that Friday, the underlying asset closed at exactly $2.53, and his April 2.50 put position was deemed worthless. For those uncertain to what having a short put means, I will refresh you with the following definition: Anytime an option is sold, the writer (seller) assumes the obligation to deliver on his or her contractual duties. In case of a short put, the seller is indebted to buy the stock at the predetermined (strike) price. In this exact example, the deal was stroked at the amount of $2.50 per share. Moreover, when the closing bell rang on that fateful Friday, the shares of the assets were trading at $2.53, as I had mentioned earlier. No one in their right mind would force the seller of the April 2.50 to buy the share of the underlying that is trading at $2.53 at the lower price of $2.50 per share. Doing this would not mathematically make sense, so no broker, specialist, or market maker would have assigned the 2.50 to the put seller.

Having said that, the issue becomes why was he then assigned those shares in the number of the contracts that he had? By the way, by the body language and the student's persistence to find the correct and accurate answer to why he was assigned, I could speculate that he did have a large position. Moreover, he was monitoring his position during the trade, so one could truthfully say that the position did not get out of his hands. He told me that when he logged in on the Monday after the expiry, he was shocked to see the loss in his account due to the position being assigned to him over the weekend. In addition, the asset, which he now owned, was heading south rapidly, according to him, and he had no stop loss on the long stock.

I kind of questioned how rapidly was something tanking that is sitting at $2.50, but did not voice it until I had looked at the chart, as well as the print (time and sales). The stock did go lower a few nickels. However, due to the large position that he now had on, even this small drop was producing a significant loss that was causing his account to go into the red.

The student was blaming the broker for the situation that he was placed in, and they were saying that it was not their fault. When he demanded them to explain what had happened in simple terms, they themselves were muddying the water, for they were not sure either.

When I looked at the print, the answer was clear. The stock did close at $2.53 on April's Friday expiry, yet the prints were showing that someone was shorting that particular stock with hundreds of shares in the after-hours trading, pushing it down to $2.47, where the stocked remained for the rest of the weekend.

Next, let me make it very clear that the options on stocks do not expire on the third Friday, but they only stop trading on the third Friday. They officially expire on Saturday prior to 11:59 AM EST. Those shorted options that are ITM (in the money) even by a penny do get assigned without any exception. In his case, because of the after-hours selloff, the sold April 2.50 put that was previously out of the money by three cents was now in the money by three cents. Therefore, he was assigned on Saturday. An e-mail was sent to his account notifying him about the transaction that had taken place in his account, yet he never checked his e-mail over that weekend. Furthermore, after the bell rang on Monday morning, the stock was being shorted some more and it sold off, passing $2.47 to $2.22 when he noticed it. By the time he overcame the shock and got off the phone with his broker, the underlying asset was trading at $2.15 and he chose to terminate his position. His order to exit was filled at $2.11.

In conclusion, this article points out a very essential factor, which is that the options on stocks do not expire on the third Friday of the month; they just stop trading on that day. The settlement is the next day—on Saturday—yet as you all already know, on Saturdays, the options do not trade. If the option contracts you are short trade in the pennies, it is better to buy back the obligation than to suffer undesired consequences. In this case, the student really wanted to own the stock after forecasting that it would stay above the support of $2.50, yet when the support was broken with the strong selling volume, he no longer wanted the stock.

As my predecessor would say: “Know thy options” before you trade them. Have green trading!

By Josip Causic, instructor, OnlineTradingAcademy.com

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