Options expiration week can be a scary time for some traders as they struggle with fears about short option contract assignment. And while the reality is that most options are not assigned, it still creates anxiety and confusion about what to do with short positions that are in-the-money.
Key Points from Today's Show:
- The expiration and assignment period is not something to fear.
- The probability of assignment does not happen as often as traders think.
- Most exercise and assignment occurs during the last days of the week of expiration.
- See episode 18 to review the assignment process and what to do if you are assigned.
Do Options Get Assigned Or Exercised As Soon As They Go In-The-Money?
- No, options usually do not get assigned immediately.
- This is especially true for options that are further out in time and expiration.
- The assignment does not happen right away because if the long call or put buyer assigns you immediately then they forfeit all of their extrinsic value in the contract.
- By converting their contract to physical shares, they forfeit any extrinsic time value left in the contract.
Example:
The intrinsic value of the options contract when assigned right away, is the difference between the strike price and the current price of the stock. If the stock is trading at $105 and you are short the $100 call options, those $105 call options might be worth $6. However the difference between the strike price at $100 and the stock price at $105, that creates the $5 intrinsic value, which is the value that it has if it were to be assigned or exercised.
The extra dollar of the option contract creates the extrinsic value. This is the time value or volatility value left in the contract. Therefore if the buyer were to exercise the contract they will be giving up that extra dollar of value. It would be a better choice to close the contract and sell it back at $6 and then buy another contract. This is the main reason why most option contracts don't get assigned when the option goes in the money.
*Note: Once the option is multiple dollars in the money, close to expiration, and starts behaving more like short or long stock then the assignment is really high.
Week of Expiration
- Most assignment starts to happen during the week of expiration.
- In the week of expiration, most of the time value is out of the contracts.
- Options contracts start to trade closer to their intrinsic value.
- Most exercise and assignment does not occur until the end of the week.
Number One Reason to Stop Worrying About Assignment [Stats from the OCC].
- Of all options contracts in 2016, only 7% were actually exercised/assigned anytime before or at expiration.
- Most assignments occurred at expiration.
- Therefore 93% of options were not exercised/assigned in the market.
- 71.3% of all option contracts were closing sells.
- The final 21.7% are options that were held through expiration and not exercised.
*Take away: most options contracts are closed before expiration.
See episode 70 to review the steps to take during expiration week.
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