MODULE 9 – HOW TO DEAL WITH EARLY ASSIGNMENT

First it is important to note that early Assignment is only an issue for American style options.

If you are trading Iron Condors on the indexes (RUT, SPX, NDX and MNX), you do not even need to worry about early assignment.

These are European Options and are cash settled. Contrastingly for ETF’s (IWM, SPY and QQQ) and single stock options there is a risk of early assignment.

Despite this in this module we will explain the risk of early assignment is almost inconsequential.

In fact, assignment when it happens can be an exceptionally good thing.

The reason why American options are almost never exercised before expiration is to do with the characteristics of an option itself.

An option has two sources of value, intrinsic and extrinsic value. Intrinsic value is the value of the option if it is exercised today, extrinsic value is the time value of the option.

The important thing about an option is that the extrinsic or time value must be equal or greater than 0.

Thus, exercising options voluntarily removes the extrinsic value for the buyer.

There are few reasons options are exercised before expiration because of this.

Generally, options could potentially be exercised early when they are deep ITM and have almost no extrinsic value left.

This can sometimes happen with dividends if an investor would prefer to exercise and receive the dividend as opposed to continue to hold the call on a deep ITM option.

Another reason might be if a large institution had an exceptionally large position, it might be cheaper to exercise early than to sell the position in the options market and pay the bid / ask spread on a less liquid underlying.

A deep ITM option can sometimes also be exercised if the borrowing rate becomes attractive.

All these are rare and even more rare is an option exercised with a lot of extrinsic value left. If this happens you won the lottery.

Despite this, depending how margin is calculated at your brokerage you may be left with a margin call.

In this case simply sell or buy back the assigned shares and sell back the other leg of the option.

The other main assignment risk, which happens more often occurs on expiration day.

This occurs when a options short leg is exactly At The Money. In this case it can become unclear whether assignment will occur.

As American Options trade after hours on Friday this can sometimes lead to some surprise assignments come Monday morning.

In this case the best way to avoid the risk of assignment is to simply close out the position on the day of expiry.

Traders that want to learn more about options assignment and exercise, should read this article.

In the 10th and final Module in the iron condor course, we will be looking at whether we should trade iron condors on indexes or ETF’s.