Learn the basics of options exercise and assignment
Understand the difference between in-the-money and out-of-the-money options
The surest way to avoid exercise or assignment is to liquidate or roll a position ahead of expiration
So your trading account has gotten options approval and you recently made that first trade—say, a long call in XYZ with a strike price of $105. Then the option expires, and at the time, XYZ is trading at $105.30.
Wait. The stock’s above the strike. Is that in the money (ITM) or out of the money (OTM)? Do I need to do something? Do I have enough money in my account? Help!
Please, please, please: Don’t be that trader. The time to learn the mechanics of options expiration is before you make your first trade. Opening an account at TD Ameritrade entitles you to a host of free trading education, including an entire course on options trading. (And at the end of this article you’ll find a short video covering the basics.)
Here’s a guide to help you navigate options exercise and assignment — along with a few other basics.
Memorize This Table (or Cut It Out and Paste It to Your Screen)
The buyer (“owner”) of an option has the right, but not the obligation, to exercise the option on or before expiration. A call option gives the owner the right to buy the underlying security; a put option gives the owner the right to sell the underlying security.
Conversely, when you sell an option, you may be assigned the underlying asset—at any time regardless of the ITM amount—if the option owner chooses to exercise. The option seller has no control over assignment and no certainty as to when it could happen.
An option will likely be exercised if it’s in the option owner’s best interest to do so, meaning if it’s advantageous from a price standpoint for the owner to take a position in the underlying security at the strike price rather than at the prevailing price in the open market. After the close on expiration day, ITM options are automatically exercised or assigned, whereas OTM options are not, and typically expire worthless (often referred to as being “abandoned”). The table below spells it out.
|If the underlying stock price is…||… higher than the strike price||… lower than the strike price|
|A long call is …||… ITM and exercised||… OTM and abandoned|
|A short call is …||… ITM and assigned||… OTM and abandoned|
|A long put is …||… OTM and abandoned||… ITM and exercised|
|A short put is …||… OTM and abandoned||… ITM and assigned|
This assumes a position is held all the way through expiration. Of course, you don’t need to do that. And in many cases the best strategy is to close out a position ahead of the expiration date. We’ll revisit the close-or-hold decision in the next section and look at ways to do that. But assuming you do carry the options position until the end, there are a few things you need to consider:
- Know your specs. Each standard equity options contract controls 100 shares of the underlying stock. That’s pretty straightforward. Non-standard options may have different deliverables. Non-standard options can represent a different number of shares, shares of stock of more than one company, or underlying shares and cash. Other products—such as equity index options or options on futures—have different contract specs.Offsetting positions will match and close. Suppose you’re long 300 shares of XYZ and short one ITM call that’s assigned. That call is deliverable into 100 shares, so you’ll be left with 200 shares of XYZ.
Exercise and Assignment: It’s Not Just at Expiration!
Standard U.S. equity options are American-style options, meaning they can be exercised anytime before expiration. If you’re short an option that’s deep ITM, it’s possible you’ll get assigned early. ITM short call positions are particularly vulnerable if a company is about to issue a dividend. (Learn more about options and dividend risk.)
- It’s automatic, for the most part. If an option is ITM by as little as $0.01 at expiration, it will automatically be exercised for the buyer and assigned to a seller. However, there’s something called a Do Not Exercise request that a long option holder can submit if they want to abandon an ITM option. In such a case, it’s possible that a short ITM position might not be assigned. For more, see the note below on pin risk, or refer to this advanced options expiration article. You’d better have enough cash. If an XYZ option is exercised or assigned and you don’t have an offsetting position, you’ll essentially be exchanging an options position for a position in the underlying. A long call or a short put will result in a long position in XYZ; a short call or a long put will result in a short position in XYZ. For long stock positions, you need to have enough cash to cover the purchase, or else you’ll be issued a margin call, which you must meet by adding funds to your account. But that timeline may be short, and the broker, at its discretion, has the right to liquidate positions in order to meet a margin call. If exercise or assignment involves taking a short stock position, you need a margin account.Short equity positions are risky business. An uncovered short call or a long put, if assigned or exercised, will result in a short position. If you’re short a stock you have potentially unlimited risk since there’s no limit to the price increase of a security. There’s also no guarantee the brokerage firm can continue to maintain that short position for an unlimited time period. So if you’re a newbie, it’s generally inadvisable to carry a position into expiration if there’s a chance you might end up with a short stock position.
A note on pin risk: It’s rare, but occasionally a stock settles right on a strike price at expiration. So if you were short the 105 calls and XYZ settled at exactly $105, there would be no automatic assignment, but depending on the actions taken by the holder of the option, you may or may not be assigned—and you may not be able to trade out of any unwanted positions until the next business day.
But it goes beyond the exact-price issue. What if an option is ITM as of the market close, but news comes out after the close (but before the exercise decision deadline) that sends the stock up or down through the strike price? Remember: The holder of the option could submit a Do Not Exercise request.
This uncertainty and potential exposure is called pin risk, and the best way to avoid it is to close your position before expiration.
The Decision Tree: How to Approach Expiration
As expiration approaches, you have three choices. Depending on the circumstances—and your objectives and risk tolerance—any of these might be the best decision for you.
Are options the right choice for you?
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Learn more about the potential benefits and risks of trading options.
Let the chips fall where they may. Some positions may not require as much maintenance. An options position that’s deeply OTM will likely go away on its own, but occasionally an option that’s been left for dead springs back to life. If it’s a long option, that might feel like a windfall; if it’s a short option that could’ve been closed out for a penny or two, you might be kicking yourself for not doing so.
Conversely, you might have a covered call against long stock, and the strike price was your exit target. For example, if you bought XYZ at $100 and sold the 110-strike call against it, and XYZ rallies to $113, you might be content with the $10 profit (plus the premium you took in when you sold the call, but minus any transaction costs). In that case, you can let assignment happen.
Close it out. If you’ve met your objectives for a trade—for better or worse—it might be time to close it out. Otherwise, you might be exposed to risks that aren’t commensurate with any added return potential (like the short option that could’ve been closed out for next to nothing, then suddenly came back into play).
The close-it-out category also includes ITM options that could result in an unwanted position or the calling away of a stock you didn’t want to part with. And remember to watch the dividend calendar. If you’re short a call option near the ex-dividend date of a stock, the position might be a candidate for early exercise. If so, you may want to consider getting out of the position well in advance—perhaps a week or more.
Roll it to something else. This is the third choice. Rolling is essentially two trades executed as a spread. One leg closes out the existing option; the other leg initiates a new position. For example, suppose you’re short a covered XYZ call at the July 105 strike, the stock is at $103, and the call’s about to expire. You could roll it to the August 105 strike. Or, if your strategy is to sell a call that’s $5 OTM, you might roll to the August 108 call. Keep in mind that rolling strategies can entail additional transaction costs, including multiple contract fees, which may impact any potential return.
The Bottom Line on Options Expiration
You don’t enter an intersection and then check to see if it’s clear. You don’t jump out of an airplane and then test the rip cord. So do yourself a favor. Get comfortable with the mechanics of options expiration before you make your first trade. Your beating heart will thank you.
Investing Basics: Options