Key Concepts 3. Trade Management

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Assignment

A short option, regardless of whether it’s a call or put, can be assigned at any time if the option is in the money. When selling a put, the seller is contractually giving the right for the put owner to sell or “put” them stock at a given price (Strike Price) in a given set of time (expiration). Selling a call gives the right to the call owner to buy or “call” stock away from the seller within a given time frame. The purchaser of an option has the right to exercise an in the money option at any time prior to expiration, but not necessarily the obligation to do so. Short options are most commonly assigned if the options expire in the money, or if there is a dividend paid out (Dividend Risk).

Short Put

When selling a put, the seller is contractually giving the right for the put owner to sell or “put” them stock at a given price (Strike Price) in a given set of time (expiration). If the strike price of the option in below the current market price of the stock, the option holder does not gain value putting the stock to the seller, because the market value is greater than the strike price. If the strike price of the option is above the current market price of the stock, the option seller will be at assignment risk.

Short Call

Selling a call gives the right to the call owner to buy or “call” stock away from the seller within a given time frame. If the market price of the stock is below the strike price of the option, the call holder has no advantage to call stock away at higher than market value. If the market value of the stock is greater than the strike price, the option holder can call away the stock at a lower than market value price. Short calls are at assignment risk when they are in the money or if there is a dividend coming up, and the extrinsic value of the short call is less than the dividend.

What happens to these options?

If an ITM call is assigned, the call seller will be short shares of stock. If the account holder does not have the funds to cover a short stock position, the brokerage will liquidate the stock at the market price. For instance, if the stock is trading at $95 and a short call at the $90 strike is assigned, the short call seller would then own the stock at $90 and have to purchase stock at $95 to close the trade. The net loss would be $5.00 per contract, less credit received from selling the call initially.

If a short put is assigned, the short put holder would now be long shares of stock at the put strike price. For example, with the stock trading at $50, the short put seller is assigned shares of stock at the strike of $53. The put seller is responsible for buying shares of stock above the market price at their strike of $53. If the put seller can not afford to hold the shares of stock, the broker will liquidate the stock by selling it at the current market price of $50. The net loss would be $3.00, less credit received from selling the put originally.

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