I got assigned–what do I do now?
I got assigned on the put option that I initially sold. What do I do? What if I don’t have the cash to cover the cost of purchasing 100 shares of the stock? How large is my maximum potential loss?
Stock assignment is not usually what we want to happen when trading spreads. But every now and again, for whatever reason, it does happen.
There are two types of assignment: early assignment prior to expiration and automatic assignment at expiration. In both cases, your broker may contact you and inform you of the assignment, but the surest way to know is to check your online account at the beginning of each trading day. Exercise and assignment only occur overnight after stocks have ceased trading for the day. So you don’t have to worry about an assignment happening during the trading day. If you don’t see an assignment in your account at the start of the trading day, it hasn’t occurred and cannot occur until the following day.
1. Early assignment — before expiration
As the expiration date approaches, your short option’s time value decays at an accelerating rate. This makes the short leg increasingly vulnerable to assignment if the stock price has moved in the wrong direction and is now below the higher-strike put you have sold. In the last three weeks before expiration, Jim is keenly watching many factors to see whether you need to roll the trade to avoid assignment. Especially in the week of expiration, check the website regularly to see if he’s issued a roll Trade Alert and if so execute the roll as soon as possible. (See also Does this roll Alert apply to me? And please do not post in Stock Talk asking when the trade will be rolled!).
Early assignment is merely a minor inconvenience that is easily rectified and doesn’t necessarily require additional funds. When you sell to open a put, you’re giving the buyer the right to “put” the stock to you, essentially forcing you to buy the shares at any time, for any reason. In rare cases, the buyer of the put you sold to open may exercise that option for reasons that don’t make sense. When the buyer exercises, you get… assigned.
If your broker notifies you that you’ve been assigned, does it mean that you must have many thousands of dollars ready in your margin account to purchase the assigned stock? No!
If you are notified of an early assignment (“notified” can simply mean the stock assignment shows up in your brokerage account), and you don’t have the desire or the means to hold on to the assigned stock, you will need to take action to exit the stock position by the end of the same trading day on which you receive the assignment notification. There is no increased margin requirement on an early assignment if you sell the stock on the day of notification because your broker knows that your risk is limited to the spread width even if you don’t have the money to purchase the stock. This one-day waiver of margin requirements is called “ same-day substitution.” Most of Jim's trades start as credit spreads with five points separating the two option strike prices, which means that you cannot lose more than $500 per contract. In fact, your maximum potential net loss is less than $500 because you received a premium payment up front when you entered the trade.
You are expected to handle exiting a stock assignment yourself, but if you fail to do so in a timely manner, and you don’t have enough funds to purchase the stock, the broker will unilaterally take action to protect itself by selling the stock for you and there is no assurance that the action taken will be in the form that is most advantageous for you. If the broker is required to take unilateral action too many times, it may decide to restrict trading in your account. Brokers do not take unilateral action unless they need to protect themselves from risk. If you have sufficient cash to handle the early assignment and did not increase the broker’s risk, they would take no action.
Okay, so you have been notified of the early assignment and are ready to make a same-day decision how to handle the assignment situation. You have three choices:
Choice #1: Sell the assigned stock and sell the lower-strike put option you are long simultaneously
Most of the time, when assigned, the best course of action is to tell your broker to simultaneously sell the assigned stock and also sell your long put in a single “covered stock” transaction for a collective net credit. This collective credit is often much higher than the credit available from simply exercising the lower-strike put and selling the stock for the lower put strike thanks to the existence of remaining time value on the lower-strike put. Jim personally use thinkorswim which has an order type expressly called “covered stock” which is why he uses that term. Not all brokers use that term so you may need to describe to them what you are trying to do. For example, Fidelity does not support a “covered stock” trade (i.e., sell stock and sell to close put option), so Fidelity customers need to sell the assigned stock by itself and then sell to close the lower-strike put in a separate transaction, which could be combined with opening a new two-leg spread as part of a three-leg roll. The important point is to sell the stock and the lower-strike put as simultaneously as possible.
Choice #2: Use your insurance policy. (When the stock price is far below the lower-strike long-put strike price)
Remember that when you originally placed the two-legged spread trade, you prudently built-in protection by purchasing a lower-strike put in case this very moment arrived. Limiting risk was the whole point of paying money for the long put leg! If the stock price has fallen significantly below the long-put strike price, then it is possible that the long put no longer possesses any time value and therefore it may be preferable to simply call your broker and exercise your long put because there is no time value remaining that would be forfeited. Deep-in-the-money puts often have a bid price below intrinsic value (i.e., strike price – stock price), so exercising the put ensures that you will receive the put’s full intrinsic value.
Choice #3: Welcome the assignment — buy stock at a discount.
Jim issues trade alerts only for solid, well-known underlying stocks. If you happen to like the underlying stock and think buying it at the short-put strike price is a bargain because it will soon rise again, why not do it? Of course, you’ll need to have the cash to purchase the shares at the short-put strike price (which will turn out to be cheaper than if you had bought the shares outright at the moment when you cleverly placed this trade instead). And by using this strategy you’ll be the proud owner of a darn fine stock.
2. Assignment at expiration
If an option is in-the-money at expiration, the option will be automatically exercised/assigned, which converts a relatively low-cost option position into a high-cost stock position. Consequently, you need to monitor your in-the-money option positions near expiration in anticipation of this likely change in margin requirement and make trade adjustments if necessary to avoid or quickly remedy the conversion of options into stock. Monthly options expire at 4:00 p.m. ET on the third Friday of the month at which time the closing price of each underlying security is fixed for purposes of determining automatic exercise. Any option that expires in-the-money by one penny or more is automatically exercised/assigned, resulting in the delivery of stock. Owners of options have until about 4:30 PM Eastern Time on expiration Friday to opt-in and notify the broker of an intent to exercise an out-of-the-money (OTM) strike.
Possible reasons to opt-in: (1) news after market close moves the stock price in after-hours trading; (2) uncertainty as to whether the option will actually close OTM; or (3) the need to exit a position before the weekend with no time to wait and see if a limit order will fill. Opting-in is a rare occurrence, but sometimes occurs if the option expires only a few pennies out-of-the-money. Consequently, it is possible that a trader could reasonably believe that his put credit spread trade safely expired worthless as he headed off to a Friday happy hour, only to find on Monday morning that the short put leg was assigned over the weekend. Some brokers will require closeout of an option prior to expiration if it is out-of-the money by only a very small amount in the last 30 minutes prior to expiration.
If the stock closes in-between the strike prices of the option legs, there is a margin problem because you will be left holding either long or short stock over the weekend without any remaining long option acting as an insurance policy (because it expired). Consequently, your broker can require that your account have the buying power necessary to purchase the assigned stock, which is a much larger margin requirement than the original spread. If you don’t have the buying power necessary, the broker will take unilateral action to protect itself and may charge you an extra $100 fee for the extra effort.
Always close out or roll a spread prior to expiration that is set to expire with the underlying stock closing in-between the spread’s option strikes if you don’t have the buying power necessary to purchase/short the assigned stock.
In contrast, if both option legs expire in-the-money, there is no need for you to take any action because your broker will automatically exercise and assign the position on your behalf, resulting in you buying and selling the stock and being left with no stock position and ensuring that your maximum loss per contract is no more than $500 on a 5-point spread, minus the initial credit you received.
Jim explains more about assignment and about the special situation of rolling a put credit spread into a call debit spread here.