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I have started writing covered puts and calls recently. Everything I read talks about the risk of early assignment of your position, but I don't really understand how often this happens. It seems that you should only exercise an option when the extrinsic value is lower than the brokerage fees for buying/selling the stock (say about $0.10). Otherwise you could always make more money by selling the option than exercising (assuming there are no dividend payouts on the underlying stock). It seems only an irrational investor would exercise an option with time value left on it, and I assume that is exceedingly rare.

I've read that early assignment of a put is more likely than a call as the money is flowing to the exerciser rather than from, which is more likely to happen early (money in as early as possible vs money out as late as possible). But it seems to me that the contract holder would still get more money if they just sold the contract (and their stock if they're holding it). Am I doing that math right?

I am trading ETFs and will start with ETNs soon. So the detailed questions are:

  • At what level of extrinsic value does the possibility of assignment become likely?
  • Is there really a risk of early assignment if there's time value left? Or is this just some CYA verbage that everyone includes because it is technically possible?
  • Does that risk change when you are looking at ETN vs ETF vs Company Stock? How?
  • Does the risk change between a put and a call?
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  • Uh...Possible duplicate? money.stackexchange.com/questions/5696/…. I promise I searched first, but I didn't find anything. SE didn't suggest anything useful when I wrote it, either. I just found the other answer through the [options-assignment] tag. Please close if I haven't asked anything new.
    – yossarian
    Commented Jan 20, 2012 at 16:48

3 Answers 3

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One reason this happens is due to dividends. If the dividend amount is greater than the time value left on a call, it can make sense to exercise early to collect the dividend.

Deep in the money puts also may get exercised early. There's usually little premium on a deep in the money put and the spread on the bid-ask might erase what little premium there is. If you have stock worth $5,000 but own puts on them that will give you $50,000 upon exercise (and no spread to worry about), the interest you can gain on the $50k might be more than the little to no time value left on the position... even at several weeks to expiration.

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  • There's no profitable arb in exercising a deep ITM call to capture the dividend (where the time premium is less than the dividend). That applies to the put, not the call.
    – Bob Baerker
    Commented Oct 23, 2018 at 18:51
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Per CBOE stats, only about 7% of options are exercised.

There are several reasons why an option might be exercised early:

  • The owner doesn't know any better and throws away remaining time premium, not realizing that he'd salvage that time premium by selling the option. This is rare.

  • The time premium is low and exit costs (commissions and B/A spread) are lower than selling the option. This is an infrequent occurrence because most firms charge for exercise, sometimes more than a simple sell commission.

  • An ITM option trades at a discount (the bid is less than the intrinsic value) and selling to close would be a haircut. Taking the opposing position in the underlying and exercising the option would avoid the haircut. This discount occurs regularly but even more often just before the ex-dividend date. For example:

XYZ is $40 Jan $35 call is $4.80

The intrinsic value of the call is 5 points. Buy the call for $4.80, shorts the stock at $40 and exercise the call to buy the stock at $35 (- 4.80 + 40.00 - 35.00 = + 20 cent profit)

Speaking of dividends, it's an incorrect statement that ITM calls are exercised early if the time premium remaining is less than the pending dividend. This was stated in another answer and is often found across the net. If you run the numbers, you'll see that you are just throwing away the time premium and that the arb loses money.

XYZ is $40 Jan $35 call is $5.30 Ex div is tomorrow for 50 cts

Buy call, exercise to buy stock, sell stock after ex-div

  • $35.00 - $5.30 + $39.50 + $.50 = - 20 cts (loser)

This assumes that you can sell the stock on ex-div morning for the adjusted close.

It is true that a dividend arbitrage is available when the time premium of an ITM put is less than the amount of the dividend. For example:

XYZ is $40 Jan $45 put is $5.30 Ex div is tomorrow for 50 cts

Buy stock/buy put, exercise after ex-div

  • $40.00 - $5.30 + $45.00 + $.50 = + 20 cents
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The put vs call assignment risk, is actually the reverse: in-the-money calls are more likely to be exercised early than puts. Exercising a call locks in profit for the option holder because they can buy the shares at below market price, and immediately sell them at the higher market price. If there are dividends due, the risk is even higher. By contrast, exercising an in-the-money put locks in a loss for the holder, so it's less common.

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  • This answer that "exercising an in-the-money put locks in a loss for the holder" makes no sense. It could be a profitable put that went ITM. It could be an ITM option exercised to avoid the haircut of the bid trading below intrinsic value. it could be part of a Discount Arbitrage. It could be because the holder is unloading a position in the underlying. So many reasons, some profitable some not, depending on the P&L of the option and possibly a married position in the underlying.
    – Bob Baerker
    Commented Oct 23, 2018 at 18:50

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