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Opening, closing and assignment of options

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Most exercises happen near expiration, but a short can be assigned on any trading day. Know how to get in, how to get out, and when a writer must perform.

In, out, and called on

Buying or writing a new contract opens a position. Getting out before expiration means a closing trade in the same contract: a holder sells the option she bought, and a writer buys back the option he sold. A holder who sells to close collects the difference between the premium paid and the current premium, so she can take a gain without the cash to exercise. Exercise is the other route for a holder: buy or sell the shares at the strike.

The premium is paid up front to the writer and is not refunded. It reflects the stock price against the strike, the time left until expiration and how much the stock’s price moves. Split it in two: intrinsic value is the amount, if any, by which the option is in the money; the rest is time value. An out-of-the-money option has no intrinsic value, so its whole premium is time value.

When a holder exercises, the OCC assigns the exercise notice at random to a firm with customers short that series. The firm then assigns a customer, at random or by another procedure of its own. An American-style holder may exercise at any time and whatever the option’s moneyness, so a writer with an open short position may be assigned on any trading day, even after a late price move on expiration day.

An assigned writer must perform: deliver the shares at the strike for a call, or buy them at the strike for a put. The only way to end assignment risk before expiration is a closing purchase of the same contract.

Exam terms

Opening transaction
Buying or writing a new contract, which creates a position.
Closing sale
A holder’s sale of the option she holds, ending her position.
Closing purchase
A writer’s purchase of the option he sold, ending his obligation.
Time value
The part of a premium above intrinsic value; all of an out-of-the-money premium.
Assignment
Notice to a writer that a holder has exercised and the writer must perform.

How an exercise reaches a writer

Holder exercisesThrough her firm
exercise notice
OCCStands between both sides
assigned at random
FirmHas customers short the series
random or firm method
WriterMust deliver or buy at the strike
No holder ever picks a writer.

Try it: Write the trade that opens and the trade that closes each of four positions: long call, long put, short call, short put. Then circle the positions that can be assigned, and write the one trade that would end that risk for each.

The ruleOpen by buying or writing; close by the opposite trade in the same contract. Premium = intrinsic value + time value; it is paid to the writer and not refunded. The OCC assigns firms at random; firms pick a short customer at random or by their own method. An open American-style short can be assigned on any trading day.

The closest contrast

Holder: sell to close.

Writer: buy to close.

This decides how-do-I-get-out questions. Whichever side you took to open, the closing trade is the opposite one in the same contract; a trade in a different contract or in the stock leaves the original position open.

Worked example

Tancredi Valsecchi wrote one 45 call for a premium of 2.00 when the stock was at 43. Three weeks later the stock is at 47 and the call trades at 3.10.

  1. His call is in the money by 2 points, so 2.00 of its 3.10 premium is intrinsic value and 1.10 is time value.
  2. Because the call is American-style and open, he can be assigned on any trading day and would then sell 100 shares at $45.
  3. To end that risk he makes a closing purchase at 3.10, paying $310 against the $200 he received: a $110 loss.
  4. Had the stock instead stayed below 45 through expiration, the call would have finished out of the money and would usually expire, leaving him the $200 premium.

Check yourself

Try a question, then read the explanation to review the rule.

Opening your study record…

Same rule, new context

Opening your study record…

Summary

  • Buying or writing opens a position; the opposite trade in the same contract closes it.
  • A holder can sell to close and keep the premium difference instead of exercising.
  • Premium is intrinsic value plus time value; an out-of-the-money premium is all time value, and none of it is refunded.
  • The OCC assigns firms at random; each firm picks a short customer at random or by its own method.
  • An open American-style short can be assigned on any trading day; before expiration, only a closing purchase ends that risk.

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