How does the process of “assignment” work for in-the-money Options?

Question

Consider the following scenario - I have a covered call for XYZ for this month's expiration as XYZ May 18 25 Call. On May 18, XYZ is trading for $28, with the option listed above at $3.3. If I unwind my position, I will garner $28-$3.3 = $24.7 minus commissions (say $10, which most online brokers charge), giving me a net proceed of $24.6 On the other hand, if I get assigned, the option will expire in-the-money, and my position will be liquidated at $25 minus assignment fee (usually higher than trade fee, say $20). Hence the proceed will be $24.8, which is higher than the unwind transaction.

Are there any other costs involved in the process of assignment, other than the broker fee?

Why then do many educational resources advise against being assigned?

Answer 1

First, it depends on your broker. Full service firms will tear you a new one, discount brokers may charge ~nothing. You'll have to check with your broker on assignment fees.

Theoretically, this is the case of the opposite of my answer in this question: Are underlying assets supposed to be sold/bought immediately after being bought/sold in call/put option?

Your trading strategy/reasoning for your covered call notwithstanding, in your case, as an option writer covering in the money calls, you want to hold and pray that your option expires worthless. As I said in the other answer, there is always a theoretical premium of option price + exercise price to underlying prices, no matter how slight, right up until expiration, so on that basis, it doesn't pay to close out the option.

However, there's a reality that I didn't mention in the other answer: if it's a deep in the money option, you can actually put a bid < stock price - exercise price - trade fee and hope for the best since the market makers rarely bid above stock price - exercise price for illiquid options, but it's unlikely that you'll beat the market makers + hft. They're systems are too fast.

I know the philly exchange allows you to put in implied volatility orders, but they're expensive, and I couldn't tell you if a broker/exchange allows for dynamic orders with the equation I specified above, but it may be worth a shot to check out; however, it's unlikely that such a low order would ever be filled since you'll at best be lined up with the market makers, and it would require a big player dumping all its' holdings at once to get to your order.

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If you're doing a traditional, true-blue covered call, there's absolutely nothing wrong being assigned except for the tax implications. When your counterparty calls away your underlyings, it is a sell for tax purposes.

If you're not covering with the underlying but with a more complex spread, things could get hairy for you real quick if someone were to exercise on you, but that's always a risk. If your broker is extremely strict, they may close the rest of your spread for you at the offer. In illiquid markets, that would be a huge percentage loss considering the wide bid/ask spreads.

Answer 2

I often sell covered calls, and if they are in the money, let the stock go. I am charged the same fee as if I sold online ($9, I use Schwab) which is better than buying back the option if I'm ok to sell the stock.

In my case, If the option is slightly in the money, and I see the options are priced well, i.e. I'd do another covered call anyway, I sometimes buy the option and sell the one a year out.

I prefer to do this in my IRA account as the trading creates no tax issue.

Answer 3

When the strike price ($25 in this case) is in-the-money, even by $0.01, your shares will be sold the day after expiration if you take no action. If you want to let your shares go,. allow assignment rather than close the short position and sell the long position...it will be cheaper that way. If you want to keep your shares you must buy back the option prior to 4Pm EST on expiration Friday. First ask yourself why you want to keep the shares. Is it to write another option? Is it to hold for a longer term strategy? Assuming this is a covered call writing account, you should consider "rolling" the option. This involves buying back the near-term option and selling the later date option of a similar or higher strike. Make sure to check to see if there is an upcoming earnings report in the latter month because you may want to avoid writing a call in that situation. I never write a call when there's an upcoming ER prior to expiration.

Good luck.

Alan