Exercise and Assignment

Exercise and assignment are the two sides of using an option. When the holder of an option decides to use their right to buy or sell the underlying at the strike price, they exercise it. The seller on the other side is then assigned, meaning they must fulfil the obligation. Most options are closed before this happens, but every options trader needs to know how exercise and assignment work, because they can turn an option position into a stock position, sometimes unexpectedly.

What exercise means#

For cash settled options, such as most index options, no shares change hands. The assigned seller pays the holder the difference between the settlement price and the strike, multiplied by the contract size.

How assignment is decided#

In the US, the Options Clearing Corporation (OCC) stands between buyers and sellers. When a holder exercises:

1. The holder's broker sends the exercise notice to the OCC.
2. The OCC randomly assigns the exercise to a broker with a short position in that option.
3. That broker assigns it to one of its customers, using a random or first in, first out method.
4. Shares and cash settle on the next business day.

Because assignment is random, a seller cannot predict which short contracts will be assigned. See Clearing Houses and Central Counterparties.

Automatic exercise at expiration#

At expiration, US equity options that are $0.01 or more in the money are automatically exercised under the OCC's exercise by exception rules, unless the holder tells their broker not to. Many brokers also close or exercise positions themselves if an account lacks the money to take delivery.

Early assignment#

American style options can be exercised, and therefore assigned, at any time before expiration. Early assignment is uncommon because holders usually do better selling the option, but it becomes more likely when:

• A short call is in the money just before an ex dividend date and the dividend is larger than the call's remaining time value.
• A short put is deep in the money, with almost no time value left.
• Expiration is close and the option is in the money.

See Early Exercise.

Assignment in spreads#

In a spread, early assignment of the short leg can leave you with a stock position while the long leg remains. For example, if the short call in a bull call spread is assigned, you become short 100 shares; your long call still protects you, but you may need to exercise it or buy shares to close the short. Brokers can charge fees and margin for the temporary position.

Pin risk#

When the underlying closes very near the strike at expiration, sellers cannot be sure whether holders will exercise, especially if the price moves after the close. A seller could wake up on Monday with an unexpected position. Closing near the money short options before expiry removes this risk. See Option Expiration Dates.

Managing exercise and assignment#

1. Close positions before expiry if you do not want shares.
2. Watch ex dividend dates for short calls.
3. Keep enough buying power for possible assignment, or trade cash settled options.
4. Know your broker's rules for expiring positions.
5. Use European style options if early assignment would cause problems. See American vs European Options.

Frequently asked questions#

What is the difference between exercise and assignment?#

Exercise is when an option holder uses their right to buy or sell; assignment is when an option seller is selected to fulfil that obligation.

Can I be assigned before expiration?#

Yes, if you sold American style options. Early assignment is most likely for in the money calls before ex dividend dates and for deep in the money options.

What happens if my option is automatically exercised?#

You receive or deliver the underlying at the strike price, which may require cash or margin, or you receive a cash payment for cash settled options.

Next, learn when exercising early can actually make sense in Early Exercise.

Sources#

• Options Clearing Corporation, Home