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What Is an Option Assignment?

Sebencapital

Published
22/12/23
What Is an Option Assignment?

DEFINITION:

An option assignment is when the person who sold the option has to follow through with the agreement. This means they might have to sell or buy the actual thing (like a stock) at the price agreed upon in the contract.

Key Takeaways

  • An assignment happens when the person who sold an option has to do what they agreed to in the contract. This might mean they have to sell or buy the real thing, like a stock, at the price they previously agreed upon.
  • When you sell an option and get assigned, you're obligated to complete the trade described in the option contract. This means you'll have to go through with the transaction based on the terms previously agreed upon.
  • Assignment occurs only when you're selling options, not when you're buying them. If you sell an option and someone chooses to exercise it, you're obliged to fulfill the terms of that option contract.
  • Assignment happens infrequently, with only about 7% of options ultimately leading to assignment.

Definition and Examples of Assignment

Assignment occurs when someone who sold an option is obligated to follow through on the terms of the deal. Imagine you sold an option to someone. By doing this, you promised to handle a future transaction if they decide to act on that option. For instance, if you sold a put option, it means you agreed to buy a stock at a specific price before the option expires.

If the person who holds the option doesn't use it by the expiration date, the option just ends. But if they decide to move forward with the transaction, they exercise the option.

When the option holder decides to exercise it, the person who sold the option gets a notification called an assignment. This notice tells them that the option holder wants to complete the deal. As the seller, you're legally bound to fulfill the terms of the options contract.

For instance, if you sold a call option for XYZ stock at a ₹40 strike price and the buyer decides to exercise it, you'll receive the assignment. That means you're committed to either buying 100 shares of XYZ at the market price or providing the shares from your own holdings and selling them at ₹40 each to the option holder.

Note

Assignment is a concern for traders who sell options. If you sell an options contract, you might face assignment, which means you're obligated to fulfill the contract's terms if the buyer chooses to act on it. However, if you're buying options, you don't have to fret about assignment. As a buyer, you have the choice to exercise the contract or not, giving you control over the situation.

How Does Assignment Work?

The options market operates through large exchanges where contracts are traded anonymously. Unlike a direct transaction, where you know the person you're dealing with, in options trading, you may not know the buyer or seller. Instead, a system handles these transactions.

In the United States, the Options Clearing Corporation (OCC) is like a hub for the options market. It ensures fair dealings by overseeing the exchange of options contracts. When someone decides to act on an option, the OCC manages the assignment process. For instance, if multiple sellers offered XYZ calls at a specific price and one is exercised, the OCC randomly selects one of those sellers to fulfill the contract.

Note

Normally, assignments aren't common in options trading. Around 7% of options are acted upon, while the other 93% simply reach their expiration without any action. As the expiration date gets closer, the likelihood of assignments tends to increase.

If you're given the duty to meet an options contract you sold, you must acknowledge the loss and fulfill the agreement. Typically, your broker will automatically manage this transaction for you.

What It Means for Individual Investors

As an individual investor, the concern about assignment arises primarily if you're selling options, but this occurrence is not very common. Less than 7% of options face assignment, and it becomes more likely as the option's expiration date approaches.

When an option is assigned, it means facing a loss as the option must be fulfilled. While this can be worrying, there are ways to mitigate this risk. You can plan to close your position before the expiration date or adopt strategies that don’t involve selling options liable for potential exercise.

Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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