Understanding Options Assignment
04/18/2011 3:00 pm EST
Option traders can watch certain factors to get a better understanding of when their options may be put to or called away from them, says thinkorswim’s Joe Kinahan. And sometimes, it’s not a bad thing to have happen.
One of the things option traders are always concerned about, or thinking about anyway, is assignment of their options and actually getting the underlying stock. Our guest today is Joe Kinahan to talk about that. So, Joe, what, first of all, is assignment of an option.
So, if I bought options, I have the right to exercise them. If you sold those to me, you have the responsibility that you could be assigned.
What exercising assignment means is on a call, I can call your stock away at the set strike price. On a put, I can put the stock to you. So, if I sell a call, I have the risk that my stock is going to be called away. If I sell a put, I may have to buy the stock at that strike price.
People are always wondering, “Is my option going to get assigned?” Even in the money, they get assigned, they don’t get assigned, or they get assigned early. How do you know what’s going to happen?
Well, first of all, there are two types of options, so let’s start there.
An American-style option can be exercised at any time during the expiration cycle. A European-style option, of which the most predominant is the SPX, can only be assigned on expiration day.
With that being said, when you sell an option, you should always be watching the corresponding.
So, if I sold a call on, say, the 50 strike, I would be watching the 50 put of that same strike, because if the corresponding put was trading for 20 cents or less, all of a sudden this could be a time where I might be getting assigned.
Again, the calls and puts are very much related. That’s not to say it’s a hard-and-fast rule. One of the rules/guidelines I like to use is if I get out of the options and I’m short four to ten days before expiration, I significantly cut the risk of being assigned.
And I’ve also heard that I should worry about assignment, because I should be happy owning the underlying if I’m in that trade.
Well, you know, one of the great IRA strategies is actually to sell a put in order to buy stock, so if I sell the put, that’s the price I’m saying I wanted to buy the stock at. So it’s like putting in a limit order that you’re getting paid for. Nothing wrong with that.
One of the areas you do have to be careful of is if you sell a call and the stock pays a dividend, because if you’re in the money, you could get it called away early because the person wants to have that stock so they collect a dividend.
Outside that four-to-ten-day window, that’s probably the biggest risk of you being assigned early.
Is there some sort of order they do assignment? Can I tell if I’m going to be assigned? Is there some kind of clue that the market will give me?
Well, like I say, that corresponding option, if I’m short a call, I look at the corresponding put. If I’m short a put, I look at the corresponding call.If they start getting under 20 cents or so, that means I’m losing the premium on the other side. They’re starting to come in the money, and I would really start to keep my eye on those then, because now I’m starting to become at a greater risk of being assigned.