Options Assignment

Assignment is the event in which the writer of an options contract is designated to perform the obligation the contract created, because the holder has exercised. The Securities and Exchange Commission's investor bulletin on options defines it directly: "when a buyer exercises his or her right under an option contract, the seller of the option contract receives a notice called an assignment notifying the seller that he or she must fulfill the obligation to buy or sell the underlying stock at the strike price." FINRA's rules call the document an "exercise assignment notice."

A naming point, because it decides what a reader is looking at. The issuing bodies' own noun is simply "assignment." This page uses the compound "options assignment" for the same reason our page on the options contract uses its compound: "assignment" on its own is a common word in finance for the transfer of a contract, a lease, a benefit or a claim, and none of those senses has anything to do with this one. The compound is a disambiguation, not a different term.

This page is about the writer's side. The instrument itself is covered on our page for the options contract, the two positions and their risk profiles on our pages for the call option and the put option, and the automatic exercise machinery that operates at expiration on our page for options expiration.

The writer holds an obligation, not a right, and that asymmetry is the whole of assignment risk. A holder decides whether to exercise, and may do so for reasons the writer cannot see. A writer decides nothing. The first the writer learns of an assignment is a notice reporting one that has already happened, after which the shares or the cash must be delivered. This is why writing options is not the mirror image of buying them in any respect other than the sign of the premium.

Allocation runs in two steps, and only the second one is discretionary. The clearing corporation matches the exercise to a clearing member with a short position in that series. The member then decides which of its own customers holding short positions is assigned, and FINRA Rule 2360(b)(23)(C)(i) constrains how: "each member shall establish fixed procedures for the allocation to customers of exercise notices assigned in respect of a short position in option contracts in such member's customer accounts. Such allocation shall be on a 'first in-first out' or automated random selection basis that has been approved by FINRA or on a manual random selection basis that has been specified by FINRA." The same paragraph requires the member to "inform its customers in writing of the method it uses to allocate exercise notices to its customer's accounts, explaining its manner of operation and the consequences of that system."

The method is not the firm's private business. Rule 2360(b)(23)(C)(ii) requires the member to report its proposed allocation method to FINRA and obtain prior approval, and forbids changing it without reporting and approving the change. Rule 2360(b)(23)(C)(iii) requires three years of work papers sufficient to establish how allocation is in fact being accomplished. So a writer who wants to know their odds can ask for the method in writing and is entitled to an answer, and the firm has to be able to prove it followed it.

First in, first out and random selection produce genuinely different exposures, which is the practical reason to know which one your firm uses. Under a first in, first out method the oldest short positions in a series are assigned first, so a writer who opened early is assigned before a writer who opened yesterday. Under random selection every short position in the series is equally exposed regardless of when it was opened. Neither is better in the abstract; they simply distribute the same assignments differently, and the difference is invisible until it lands on you.

Assignment can be partial, and this catches people who think of a position as one thing. A writer short five contracts in a series may be assigned on two of them. The remaining three stay open with their original terms. For a covered writer that means part of the underlying is called away and part is not; for an uncovered writer it means the obligation has been partly discharged and partly not, with the rest still live until expiration.

What must happen next is set by rule, not by convention. Rule 2360(b)(23)(D) requires that, as promptly as practicable after an exercise notice is assigned to a customer, the member require that customer to deposit the underlying stock in the case of a call option "if the shares of the underlying security are not carried in the customer's account," or make full cash payment of the aggregate exercise price in the case of a put option, or, where the transaction is in a margin account, to make the required deposit under Rule 4210 and the Federal Reserve Board's regulations. A covered writer already holding the shares has nothing further to deposit; they are simply delivered. A writer assigned on a call who does not own the shares is short the stock and must cover; a writer assigned on a put owes the full strike price in cash.

Early assignment is a feature of American-style contracts rather than an accident. A holder of an American-style equity option may exercise at any time up to expiration. Assignment before expiration is therefore always possible while a short position is open, and the only reliable way to eliminate the exposure is to close the short position by buying the contract back. Rolling, hedging or watching the price does not remove it.

A holder submits an exercise notice to the clearing corporation. The clearing corporation assigns a clearing member carrying a short position in that series. The member allocates the assignment to one of its own customers using the fixed method it has filed with FINRA, and notifies that customer. The customer then delivers the underlying, or pays the exercise price, or posts the required margin.

A hypothetical illustration of a partial assignment on a call. Suppose Marisol has written 5 call contracts on a stock with a $50.00 strike, representing 500 shares. Her firm allocates assignments on a first in, first out basis and has told her so in writing.

The stock rises and holders begin exercising. Overnight, the clearing corporation assigns Marisol's firm a quantity of exercises in that series, and the firm's first in, first out procedure reaches 2 of Marisol's contracts, because she wrote them earlier than most of the firm's other short positions in that series.

She must deliver 200 shares (2 contracts times 100 shares) at the $50.00 strike, receiving $10,000.00 (200 times $50.00), whatever the market price is that morning. Her other 3 contracts, covering 300 shares, remain open on their original terms, and can be assigned later or can expire. If she did not already own the 200 shares, she is short 200 shares and must buy them at the market to close, which is the uncovered writer's exposure our page on the call option sets out. All figures are illustrative and ignore fees.

What the assignment rules get right

• The allocation method must be fixed in advance, approved by FINRA, and disclosed to customers in writing, so it is not decided case by case when an assignment lands.
• The firm must keep three years of work papers showing how allocation was actually done, which makes the disclosed method auditable rather than aspirational.
• Both permitted methods, first in first out and approved random selection, are mechanical, so no customer relationship influences who is assigned.
• What the assigned customer owes next is specified by rule rather than left to the firm's discretion.

Where it catches writers

• The writer has no control over whether or when assignment happens, and finds out afterwards.
• Assignment can be partial, so a position a writer thinks of as a single trade can be half unwound without warning.
• On an American-style option the exposure exists for the whole life of the contract, not only at expiration, and the only way to end it is to buy the contract back.
• A writer assigned on a call who does not own the shares becomes short the stock, which converts a defined options position into an equity short with its own borrowing and buy-in problems.
• A writer assigned on a put must produce the full exercise price in cash, or the required margin, promptly.
• Which allocation method a firm uses changes a writer's real exposure, and it is disclosed in account paperwork most people do not read.