Covered Call Writing: Early Exercise Of Options

When we sell a cover call choice, we are undertaking an duty for which we are well paid. Should the option holder decide to exercise that option, we must sell our shares at the specified hit price at or prior to the passing date. This is the nature of american stylus options as opposed to european style options. American manner options : an option contract that may be exercised at any prison term between the go steady of leverage ( sale ) and the passing date. These are the options that we, as CC writers, distribute with. european vogue options : an option contract that can only be exercised on the termination date. For the most part, share assignment will not occur until after exhalation Friday when the agreed upon strike price is below the stream market rate. For exemplar, if we sold the $ 50 strike and the current respect of the stock is $ 52, the option holder or brokerage will exercise that choice and achieve a $ 2 per plowshare profit.

Why aren’t most options exercised early ? Option value consists of intrinsic + prison term measure. early exercise will result in the holder surrendering this clock value, so it rarely occurs. The choice owner may sell the call to capture the time value but early exercise and leverage of our shares does not make sense if there is significant time value remaining ( $ 0.25 or more ). It ’ south dependable that the shares can be purchased and then sold at market to capture this value but why not merely sell the address ? This concept applies to I-T-M and at or near-the-money strikes as O-T-M strikes would never be exercised. How is it determined which shares are assigned if early assignment ? This is a wholly random summons whereby the Options Clearing Corporation ( OCC ) decides to which brokerage the assignment will be given and the brokerage will then pass it on to one of its clients. Why does early assignment occur ? As time value declines ( below the aforesaid $ 0.25 ), the chances of early grant increases. There are times when the calls craft below the intrinsic value and in these cases the chances of early assignment are much greater. This will occur when the strike is trench I-T-M. Let ’ s expression at the options chain for Vance Info Technologies ( VIT ), as an exercise : Early Assignment Possible for $12.50 Call
Early Assignment Possible for $ 12.50 Call note that the intrinsic respect of the $ 12.50 call is @ $ 3.25 ( since the stock price is $ 15.75 ) and even the bid or our sale price of the option is $ 3.10 ( red traffic circle ). not merely is there no time rate for this option but it is actually trading below the intrinsic value. The last sale was @ $ 3.25 which is actually the accurate amount of intrinsic value. The $ 15 strike, on the other hand, has time prize of $ 0.35 ( $ 1.10 – $ 0.75 ). As your strike moves deeper I-T-M, the chance of early assignment increases.

Other factors that may lead to early assignment : 1- Dividends- When your equity is about to distribute a dividend, early assignment is possible for I-T-M strikes when that dividend rate is greater than the time value remaining for that choice. This will take seat prior to the ex-dividend date or the date share ownership is required to be eligible to capture this dividend. 2- High Open Interest- When you see thousands of open contracts we know that the institutional players are involved. Their trading costs are near zero and their arbitrage opportunities are greater than ours when meter respect approaches zero. 3- Pinning the Strike- when puts and calls are near the money on exhalation Friday, there is a leaning called pinning the strike for the stock to move to the strike monetary value or slightly beyond. This may result in assignment ( not early, but unexpected ) after the bell. This can besides take place if there is a report or late news coming out the day of termination. How to avoid assignment : 1- To generate more cash ( mid-contract ) – If there is little or no time rate remaining in our option ( sold ) why not unwind our situation ? B-T-C the call and sell the stock thereby re-capturing the time value. now take that pile of cash and re-invest it in another CC placement. You can besides roll the name out or up and out if the calculations are friendly. Remember, CC writers are hood “ bosses ”. No vacations or days off for our cash. They are put to work at all times during convention market conditions. 2- To avoid tax consequences- If your cost basis is much lower than the current grocery store rate of your shares, appointment may result in an unfavorable tax consequence. In these cases, you will want to close or role your calls before assignment. If your shares are by chance assigned, you can purchase raw shares at market and inform your broker that these modern shares are to be the ones associated with the put choice. Please check with your tax adviser and brokerage on these matters.

Conclusion : early appointment of your shares is rare but possible. Understanding why and when it may occur will further add to the bottom line of your investment success. Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the following 72 hours .

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