In the world of options trading, one critical concept to grasp is “option assignment.” It’s the process where the option buyer exercises their right to buy or sell the underlying security at the agreed-upon strike price. The option seller, also known as the option writer, is selected by the Options Clearing Corporation (OCC) to fulfill this obligation. Option assignment can occur at any time before the option’s expiration, but it’s more likely when the option is in the money (ITM) and near its expiry.
Option Assignment Example
Let’s illustrate this with an example from India:
Imagine you sell a Nifty 18000 Call option with an expiration date of October 28, 2023, and collect a premium of ₹200 per share. This means you have an obligation to sell 75 shares of Nifty (the lot size) at ₹18,000 per share if the option buyer chooses to exercise their right.
If Nifty’s price rises above ₹18,000 before October 28, 2023, the option buyer may decide to exercise it. In this case, you will be assigned by the OCC, requiring you to sell 75 shares of Nifty at ₹18,000 each, regardless of the current market price.
Your profit or loss from this trade hinges on the difference between the premium received and the cost of selling Nifty shares.
- If Nifty is trading at ₹18,500 per share when assigned, your loss would be ₹52,500.
- If Nifty is trading at ₹17,500 per share when assigned, your profit would be ₹52,500.
- If Nifty remains below ₹18,000 until October 28, 2023, the option expires worthless, and you keep the premium as your profit, which in this case is ₹15,000.
Some Things to Know About Options Assignment
Timing is Crucial
Options assignment can take place at any time before the options contract expires. However, it’s more likely to occur as the options expire, especially when they are in-the-money (ITM). When an option is ITM, it means there’s actual value in exercising it because it’s profitable.
Impact on Sellers
When you’re the seller of an option, being assigned can have significant consequences. It could lead to either gains or losses, depending on how the underlying asset’s price has moved. If the market moves against your position, you might end up selling or buying the asset at an unfavorable price.
One way to avoid the potential hassles of assignment is by closing out your short options position before they reach their expiration date or become ITM. This enables you to lock in your profits or limit your losses, eliminating the risk of being assigned. Alternatively, you can employ more complex strategies like spreads to hedge your risk and reduce your net premium exposure. However, these strategies come with their own complexities and costs.
It’s crucial to ensure you have enough capital in your trading account to meet your potential obligations resulting from selling options. Regularly monitoring your positions is key to managing your risk effectively. If needed, be prepared to adjust or exit your trades to safeguard your interests.
Don’t underestimate the importance of education. Learning about options assignment, including breakeven points, pros, and cons of various strategies, is essential for making informed decisions in the world of options trading.
Option assignment is a crucial aspect of options trading in India, and it’s essential to comprehend its dynamics for making informed decisions in the market. Whether you’re a seasoned trader or a beginner, understanding option assignment is key to navigating the world of options trading effectively. If you’re eager to learn more about this topic, you can explore additional resources or feel free to ask any questions you have. Happy trading!
The assignment of a call option occurs when the seller is obligated to sell the underlying asset at the strike price to the buyer who exercises their right. The seller receives the strike price per share but foregoes any potential profit from holding or selling the underlying asset at a higher price.
To avoid options assignments, consider closing short options positions before they expire or become in-the-money (ITM). This locks in profits or losses and eliminates assignment risk. Alternatively, use strategies like spreads involving buying and selling options of the same type but different strike prices and expiration dates to hedge risk and reduce net premium exposure.
Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.