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Option basics: Short call assignment

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Often when selling options naked, as occurs with the short Strangle, you may face assignment. Assignment occurs when your position is ITM (in the money) and the other party to your option (the buyer) decides to exercise his right to the underlying asset.

For example, if you're short the Put on a stock option, upon assignment you will be required to buy the stock from the buyer at the strike price, and your account will be long the stock. This will likely occur if the current price of the stock is below the strike price at or near expiration.

But what happens when you are short the Call and you are assigned? Well, the broker will then short the stock in your account and sell the shares to the buyer of the Call at the strike price. In other words, your account will have borrowed the shares from the broker to fulfill your obligation under assignment. However, if you instruct your broker to purchase the shares from the market upon assignment (and not borrow the shares), then your account will be flat; you will not have a short position in the stock.

Note: you must contact your broker in advance and determine whether they will accept your instructions to buy and not borrow; it is far more likely they will not accept your instructions. Therefore, you should understand the risks associated with being short stock.

There are valid reasons for not wanting to be left with a short stock position, and this is due to the following inherent risks...

  • Market risk: if you feel the stock is going to continue further up
  • Dividend risk: you will have to pay the dividend on and after the ex-dividend date
  • Spinoff risk: this occurs if the company issues warrants or spins off ownership of a company (an example is Altria in 2007 which spun off Kraft; then you will be shorted two separate stocks, making the situation more complicated and costly)
  • Buy-in risk: where the broker forces you to buy the stock to close the position. This occurs when the stock is increasing and the original shareholder wants to take profits.
  • Margin calls: as the stock increases in value, you are required to maintain at least 50% of the total value of the short position.
  • Hard-to-borrow-rate: you will be charged additional fees (a borrowing rate) if the broker has to borrow the stock from another broker. However, the rate can range from a fraction of a percent to above 100 percent of the principal value of the trade depending on market demand. Typically the rate is under 3%, but this could change as market conditions change.

In conclusion, understanding your alternatives when it comes to assignment, especially for a short Call position and the inherent risks associated with a short stock position, will help you to formulate a proper response and avoid unexpected pitfalls that could be costly.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.Often when selling options naked, as occurs with the short Strangle, you may face assignment. Assignment occurs when your position is ITM (in the money) and the other party to your option (the buyer) decides to exercise his right to the underlying asset.

For example, if you're short the Put on a stock option, upon assignment you will be required to buy the stock from the buyer at the strike price, and your account will be long the stock. This will likely occur if the current price of the stock is below the strike price at or near expiration.

But what happens when you are short the Call and you are assigned? Well, the broker will then short the stock in your account and sell the shares to the buyer of the Call at the strike price. In other words, your account will have borrowed the shares from the broker to fulfill your obligation under assignment. However, if you instruct your broker to purchase the shares from the market upon assignment (and not borrow the shares), then your account will be flat; you will not have a short position in the stock.

There are valid reasons for not wanting to be left with a short stock position, and this is due to the following inherent risks...

  • Market risk: if you feel the stock is going to continue further up
  • Dividend risk: you will have to pay the dividend on and after the ex-dividend date
  • Spinoff risk: this occurs if the company issues warrants or spins off ownership of a company (an example is Altria in 2007 which spun off Kraft; then you will be shorted two separate stocks, making the situation more complicated and costly)
  • Buy-in risk: where the broker forces you to buy the stock to close the position. This occurs when the stock is increasing and the original shareholder wants to take profits.
  • Margin calls: as the stock increases in value, you are required to maintain at least 50% of the total value of the short position.
  • Hard-to-borrow-rate: you will be charged additional fees (a borrowing rate) if the broker has to borrow the stock from another broker. However, the rate can range from a fraction of a percent to above 100 percent of the principal value of the trade depending on market demand. Typically the rate is under 3%, but this could change as market conditions change.

In conclusion, understanding your alternatives when it comes to assignment, especially for a short Call position and the inherent risks associated with a short stock position, will help you to formulate a proper response and avoid unexpected pitfalls that could be costly.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.

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