Option Basics

Early Assignment

I’ve heard it said that most options expire worthless. This claim generally comes from non-option traders trying to convince would-be traders not to start. It’s just not true. The vast majority of option positions are simply closed before expiration. Even though a large number expire, plenty are exercised/assigned.

The term exercise refers to an option buyer exercising their right granted by the option. Call buyers have the right to buy stock at the strike price anytime before the option expires. Put buyers have the right to sell stock at the strike price anytime before the option expires. Their act of doing so is known as exercising.

The term assignment refers to an initial option seller, also know as the option writer, being exercised by the buyer of their option. Call writers have the obligation to sell stock at the strike price anytime before the option expires. Put writers have the obligation to buy stock at the strike price anytime before the option expires. When they are forced to fulfill their obligation, it is known as being assigned.

The last day for option buyers to exercise their rights and option writers to be assigned their obligations is on expiration Friday. Technically, option expiration happens the Saturday following the third Friday. Since the stock market is closed on Saturdays and since most brokerages also make their retail clients announce their intentions by the third Friday, most people consider this day as option expiration day.

On stock options, the buyer of an option can exercise their right at any point until expiration. That is any time they want, but it won’t reflect when the market is still open. The shares will trade hands after normal hours. Disappearing from the assigned Call writer’s account and/or appearing in the assigned Put writer’s account, before the open of the next business day. Their broker should inform them of assignment before the market opens.

Most exercise/assignment takes place on the last day, expiration day. But since stock option buyers can exercise their rights at anytime until expiration, it is possible to take place “ahead of schedule.” When an option buyer chooses to do so, it is known as early exercise. Logically, when the writer receives notification, it’s known as early assignment.

Selling Naked Puts has its own risks and rewards. Some aspects, which are thought to be risks, may actually be rewarding. Early Assignment falls into this category.

Calls are almost never exercised early. If their buyer does so, he has to come up with the money to pay for the stock. On the other hand, Put buyers often exercise early. When they exercise their right to sell stock, they get paid. They collect the money for the sale. I’ve been assigned early on Puts numerous times. I’ve been called out early only once in the last few years. I know very few Covered Call writers that have ever been called out early. Money has value; it collects interest. Follow the money!

Time Merchant

Selling options is akin to selling time. Option writers collect premium by obligating themselves for certain periods of time. If the buyer of those options decides not to exercise the time will expire and with it the option. But if the option buyer chooses to exercise early, they aren’t using time they’ve previously paid for. Maybe it can be resold.

Option buyers can sell their options anytime the market is open. As long as there is time value remaining, they would be foolish to exercise. By doing so they lose the time value. If and when they do, they have to lose it to someone. That someone could be you. Be aware, this opportunity generally never avails itself, but when it does, be prepared to profit.

Usually options are only assigned early when they are so Deep In the Money (DITM) they have no time value. Also early assignment might happen one or two weeks before expiration, but not often any earlier than the last week before.

How To Profit When Assigned Early Using a Totally Hypothetical Example:

Stock XYZ closed @ $ 33. The $ 40 Puts closed @ $ 7.50 bid, $ 8.00 ask. Their intrinsic value equals the amount In the Money (ITM) $ 7. Whatever remains forms the time value, in this case less than a dollar. But instead of selling the Puts on the open market, their buyer chooses to exercise early. If we wrote these Puts and were the early assignment “victim,” we could receive a windfall profit.

There’s two ways to resell the time. One way is to sell a Covered Call against the stock just bought. If the prices remain the same the following day when we found out we were assigned early, the $ 40 Call should be priced around $0.50 bid, $0.75 ask. Although we may get a better price than bid, let’s assume we sell the Call @ $0.50. If the stock rises above $ 40 and we get called out; it’s the same net effect as never being Put in the first place. We would NOT own the stock, but we would have picked up an extra $0.50.

Selling options can be very profitable. To the trained trader the numerous risks are more than offset by the potential rewards, including those that almost never appear. Training comes from experience; not necessarily one’s own. Being aware of circumstances that hardly ever appear allows profits if/when they do appear.











Time Value and Time Decay:




In business, the key is not to be part of the crowd, but to know the direction of the crowd.  Don’t be a follower; try to be a leader.  If you can’t beat ‘em, DON’T join ‘em!  You should watch the crowd.  Don’t join in their herd mind-set, least you join a band of lemmings parading over a cliff.  Crowds may be right in the middle, but they’re wrong at the ends.  They buy high and sell low, the exact opposite of successful trading.

The crowd watches CNBC and so do the experts.  Go into most brokerage offices and/or trading rooms across this country and chances are they will have a TV tuned to CNBC.  Not because it’s their best source of information on the market, but because it’s their best source of info on the trading public.

CNBC only reports the news they don’t make it, or do they?  They have no bearing on prices, or do they?  Have you heard of the “CNBC Effect?”  The “CNBC Effect” takes place when the crowd reacts to the information shared with them via CNBC.  Viewers watch and listen for tidbits of information, any tip construed or otherwise, any reason to buy or sell.


If you watched long enough, you’ve seen a CEO give a stellar interview.  Soon on the streaming ticker tape flowing across the bottom of the screen, you see the stock increase in frequency and price.  Or you might have seen a CFO stutter when asked about future earnings or worse still, accounting irregularities.  Shortly there after that stock may trade much lower in price on higher volume.

Can option traders use CNBC to their advantage?  The answer is yes!  But you need the big picture.  Some of the details may seem old hat or trivial.  When finished looping off in opposite directions, it ties nice and neatly into a bow.

Stocks are one-dimensional; price.  Options have many components: price, time and potential.  Compared to potential, price and time are easy math. Potential is a difficult concept to understand.  (Older Options 101 columns go into option pricing in greater detail.)

Volatility measures potential.  Higher potential moves in either direction produce higher Volatility.  Higher Volatility equals higher option prices.  Higher option prices mean higher potential moves, or so the formula says.  In actuality, higher option prices indicate higher Implied Volatility, but not greater potential.

Volatility comes in four different flavors.  Implied Volatility gives novice option traders a sour taste.  Another way to look at Implied Volatility is to consider it as supply and demand.  More buyers, Implied Volatility increases.  Fewer buyers and/or more sellers, Implied Volatility drops.  True potential has nothing to do with it.  There is a skew between actual and assumed probabilities, a mathematical edge. 

Option traders don’t need stock prices to move if they have correctly bet on option pricing components.  The “CNBC Effect” can and does often change Implied Volatility without ever changing stock prices.  Do not assume the additional exposure of stocks featured on CNBC will increase their Implied Volatility!  But don’t be surprised if it happens.

Being aware of the trading environment transforms option trading from betting to investing.  Anticipating future changes based on previous tendencies increases profitability.  Knowing what to expect and not being blind-sided decreases losses.  Avoiding crowds help avoid stampede disease, being trampled.























The five levels are:

Level One; selling covered calls.
Level Two; buying puts and calls.
Level Three; spreads.
Level Four; selling uncovered (naked) puts.
Level Five; selling uncovered (naked) calls.




Levels Three through Five require a margin account.







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