Why would a short option be assigned early? (US options and futures)
A short option can be assigned at any time because the long option holder has the right to exercise whenever they want. Why is this? Equity options are usually American-style. That's not because they trade on American exchanges, but rather, the method in which the owner of the option can choose to exercise their long option, which results in an assignment if you were short the option.
When the holder of a long option submits an exercise request with their broker, the request will go to the Options Clearing Corporation (OCC), and they will randomly select a broker with an account holding the short side of the corresponding options contract. The OCC refers to the random options assignment process as the "Assignment Wheel." The "wheel" refers to the random account selection process after an exercise request. The short options holder will see the resulting position after the OCC randomly selects the broker and locates the account with the corresponding short position.
According to the Options Clearing Corporation, (long) options holders only exercise about 7%* of options. Particular market situations and periods could cause investors with short options to be part of that statistic and experience heightened assignment risk. As mentioned earlier, early assignment risk only applies to American-style options (equity options). All in all, it's essential to understand that assignment is random, and investors holding any short options contract will not know the intention of why a long holder exercises their long options position. However, there are three primary situations where it is much more likely that you could be assigned early.
Dividend risk
Investors short any options strategy with a short call contract on a dividend-paying stock is subject to dividend risk, which means the investor may owe the dividend if assigned short shares before the ex-dividend date. Dividend risk elevates when a short call is ITM, and the corresponding put is worth less than the upcoming dividend payment. The only way to eliminate any dividend risk potential is by closing any short call options position before the ex-dividend date.
| Early assignment risk can be higher near ex-dividend dates |
Hard-to-borrow securities (HTB Rates)
Investors with short calls may have heightened assignment risk when HTB fees are high because it could be more beneficial for the long call holder to exercise the option to receive long shares and lend them out due to the high HTB rate. In some respects, a high HTB fee can act like a "synthetic dividend." Also, since HTB fees are charged daily from settlement to settlement, short call(s) may have a higher assignment risk on Wednesdays or Thursdays to take advantage of any HTB fees charged over the weekend.
Higher HTB fees may indicate higher assignment risk |
Minimal extrinsic value near expiration or deep ITM positions
Little to no extrinsic value near expiration or being deep ITM Generally speaking, an option's extrinsic or time value tends to decay when it approaches expiration. As a result, investors holding an ITM long call or put could be more inclined to exercise it because the option no longer has any or much extrinsic value remaining. Since any extrinsic value is foregone when exercising a long options contract, investors may feel more inclined to exercise instead of closing the contract. Additionally, as an option goes deeper ITM it may have little to no extrinsic value. As a result, the contract may only trade at or near its intrinsic value, despite how many days to expiration remain on the contract.
