Stock Option Assignment
By strict definition, this term basically means the transfer of a person’s rights to another person or business. In terms of stock options, it refers to a notice given to an option writer that states the option (that was sold to a buyer) has officially been exercised. Exercised as in executed, not exorcised, which would have an entirely different meaning. Whenever a seller has been assigned then he or she is obligated to finish the requirements as stated in the option. For instance, if the option was a call then the writer/seller of the option would have to sell the security at the agreed upon price.
The OCC and the stock option assignment process
When the holder of an option wants to exercise the option he/she notifies his/her broker. The broker will notify the Options Clearing Corporation (OCC) of the event. After this, OCC fulfills the rest of the contract and then selects a firm that happened to be short the same contract. After notifying the firm, this group will then carry out the obligation as specified by contract.
They will choose a customer who was short the option for the official assignment. (The customer can be anyone from a random person, to a first-come or even first out basis) The customer is then assigned the exercise, which requires that he or she complete the obligation. Remember that the person is not actually buying the call—on the contrary he is buying the stock at the stated strike price.
Take a moment to consider who the OCC really is. The Options Clearing Corporation (OCC) was first opened in 1973 and is currently the largest equity derivative clearing organization worldwide. It is a clearing firm that works with commodities, commodity options and security futures. They play the part as guarantor to each of these contracts, and try and make sure that all contractual obligations are completely fulfilled, as they are essentially clearing these deals and taking responsibility.
This organization operates under the watchful eye of the Securities and Exchange Commission (SEC) as well as the Commodity Futures Trading Commission (CFTC). The OCC clears put and call options on regular stocks, stock indexes, foreign currencies, interest rate composites and single-stock futures, as well as other types of equities. It also works with futures contracts. This organization is controlled by a board of directors. Most of the revenue is made from clearing fees that come straight from its members. The OCC cooperates with all of the top exchanges in the United States, including the American Stock Exchange, International Securities Exchange, NYSE Arca, Chicago Board Options Exchange, the Boston Stock Exchange and the Philadelphia Stock Exchange.
American Options Trading
With American style options, assignment can happen at anytime. With European style options, assignment can only take place when the option is about to expire. Many traders, especially newer ones are afraid of getting assigned stock when they sell options.
Unless the option is in the money and there are only a few days left to expiration assignment is not something to worry about. Even if a trader is assigned stock, either long or short, the trader can turn around and exit that position in the market.
If you sell a covered call, you own the stock and sell a call against it. In this case, you want your stock to be called away (sold at the stock price) since that results in the highest percentage profit.
On the other hand if you are interested in buying stock at a certain price, you can sell a naked put option at the price you would be happy buying the stock and if the stock gets to your price, you will be “put’ the stock – which means you will have to buy it at that price. You also get a credit in the amount you sold the option for. So you get a discount on the stock as well.
Index option trading
When trading index options, it is good to know that these are cash based and so there is no stock involved. If you are “assigned” your broker will just take the money out of your account.