During expiration weeks I get a lot of questions about options exercising and assignment. Mostly traders are 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.
First, Be Mindful of Your Strike Price
Exercising 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 stock price — a call is then considered out of the money (OTM). An at-the-money option (ATM) is one whose strike price equals (or nearly equals) the stock price.
OTM Options = Low Probability of Exercise/Assignment
Although an option holder has the right to exercise his or her options position prior to expiration regardless of whether the options are IN or OUT of the money; the reality is that if you are holding a short option an your strikes are OTM then you stand 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 option to avoid assignment or exercising. 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 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.
Thoughts On Exercising and Assignment?
Hopefully this helped clear the air - is there anything I didn't cover that you have questions about? While it is rare to have been assigned, if you have either been assigned or exercised your own option positions I'd like to hear how the process went via the comments below.