During expiration week I get a lot of questions about options exercise and assignment. Traders are mostly concerned that their short option contracts or spreads will be assigned at expiration.
In an effort to help calm the nerves during the crazy period, I decided to put together this guide to help you understand your risks during expiration week.
Be Mindful of Your Strike Price
Exercise and assignment is nearly all about where your strike price is in relation to the current stock price at expiration.
When the stock price is above the strike price, a call is considered in-the-money (ITM). The situation is reversed when the strike price exceeds the stock price — a call is then considered out-of-the-money (OTM). An at-the-money option (ATM) has a strike price equal to (or nearly equal to) the stock price.
OTM Options = Low Probability of Exercise/Assignment
Although an option holder has the right to exercise their option position prior to expiration regardless of whether the option is IN or OUT of the money, the reality is that if you are holding a short option and your strikes are OTM then you have a very small chance of being assigned.
If you are holding short ITM option positions at expiration I would start planning an exit strategy quickly. Buying back the position is usually your best decision to avoid assignment or exercise. And please for the love of Buffett, don't wait until the last day!
Be Cool: Most Options Are Closed Before Expiration
According to OCC statistics for the year 2010, the breakdown of option expiration and exercising is as follows:
Closing Sells - 71.6%
Exercised - 7.9%
Unexercised at Expiration - 20.5%
Pretty great numbers for short option sellers, right? Of all the options that went to expiration, only 7.9% of the positions were exercised or assigned, leaving the vast majority either closed out ahead of time or worthless.