S&C Magazine Current Contents Q & A Explore Your Options MATH ASSIGNMENT
MATH ASSIGNMENT
- Details
- Parent Category: Q & A
- Category: Explore Your Options
- Written by Tom Gentile
With assignment of a short call prior to expiration a possibility on equity options, when should I expect this type of risk?
Equity options fall under the category of being American style, wherein and as stated there is the risk of assignment for those holding short contracts, either a call or a put. With regards to the call, the good news is that an early assignment is typically very clear as to when it might occur.
The only normal situation in which it might make sense for the trader long the call to exercise the contract is immediately in front of an ex-dividend date in order to collect the payout. This is due to the fact the call doesn’t maintain the rights of common stock and will, in effect, go down by the price of the dividend and thus forfeit that amount if left unexercised. But for the call to have assignment risk, you must also realize that the contract needs to be deep enough in-the-money to make the exercise into long stock attractive.
If the dividend payout is smaller than the corresponding, same-strike put market value, the trader would actually be better off holding the call rather than exercising for the dividend. The reason is simple enough; the process of exercising in this situation is the same as selling a call and buying long stock to establish a buy-write for the price of the dividend. As the buy-write is the synthetic equivalent of a short put, we only need look to that contract’s current market value to determine if assignment risk is high.
In other deep-call situations prior to expiration, the trader long the call doesn’t have any economic incentive to exercise the contract. At the end of the day or, more aptly, during the life of the call, it will be more cost-effective and less risky to hold a call due to its defined, limited-risk structure and reduced capital requirement compared to an equivalent position of long stock.
