MANAGING OPTION CONTRACT ASSIGNMENTS
Managing Option Assignments and Actions:
When faced with the possibility of an option assignment, there's several action items that can be deployed. Depending on your strategy, there’s a few different paths one can take to absorb the assignment or avoid the assignment altogether. For a risk-defined put spread trade facing the possibility of assignment, the following actions can be taken:
1) You can sell-to-close the lower strike protection leg if you want to be assigned shares
2) You can buy-to-close the higher strike leg and sell-to-close the lower strike leg to take the loss on the option contract and avoid assignment
3) Repeat number 2 above and open another put spread position at a lower strike and a further dated expiration to take in new premium to off-set the realized loss (i.e. rolling the trade)
4) Wait and see if the shares trade higher closer to or above the higher strike prior to expiration then execute number 2 to close out the position and mitigate losses if possible
5) Absorb the shares and either sell immediately on the following trading day or leverage these shares and start selling covered calls against this position while collecting dividends
A pending put spread trade is currently in the money with a $45 strike and a $42.50 protection strike. The premium income was $0.22 per share thus the breakeven is $44.78 per share. It's noteworthy to point out that assignment could happen at any time since shares are trading below the $45 strike between now and expiration.
If the shares trade below $42.50 by expiration, the brokerage account will auto assign at $45 AND auto exercise the protection leg at $42.50 for a cancellation event with a max loss result. If you're assigned shares before expiration and the shares trade below $42.50 at expiration then the shares will auto sell at $42.50 over the weekend since the protection leg is still active. Auto exercising the protection strike at $42.50 and selling shares at $42.50 will cap any losses at $228 per contract. The math here is assignment @ $45 - exercise sale @ $42.50 to cap losses = $250. The $250 of leveraged capital less the premium income of $22 = $228 max loss per contact.
If the shares trade above $42.50 by expiration, the brokerage account will auto assign at $45 and the account will need to absorb the shares. The $42.50 protection leg will not be auto exercised because it will not be a max loss situation and this leg will expire worthless. If you're assigned shares and the shares remain above $42.50 the shares will be assigned at a net price of $44.78.
Being assigned shares is the scary side of options that is rarely discussed or avoided altogether. Here I demonstrated what actions I take to manage potential assignments. Option traders sometimes struggle as to what actions to take when shares are potentially assigned. Often times option traders lose the long-term perspective and discontinue the options-based approach prematurely. However if you’re patient these potential assignments can be navigated to generate positive outcomes. Employing the strategies outlined above, one can mitigate further unrealized losses, decrease average share price and collect dividend income throughout the process.