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This is a level 1 question.
I've recently heard someone use the term "assign an option" and was wondering what they meant. Can you tell me what that means?
Remember that an option gives the holder (or buyer) the right, but not the obligation, to buy (for a call) or sell (for a put) a certain number of shares per option contract (usually 100 shares) at a specified price (the strike price) before a specified date (the expiration date). The option writer (or seller), on the other hand, must fulfill that obligation by selling (buying) the shares for a sold call (put).
At any time prior to expiration, an option holder can notify his broker of his desire to exercise his option, which means that he wishes to purchase the shares (call) or sell the shares (put). His broker then notifies the Options Clearing Corporation (OCC), which issues all listed option contracts and controls all options transactions. The OCC then randomly selects a member (brokerage) firm that is short that option and notifies the short firm that they have been assigned. The member firm then allocates that assignment to one or more of its customers (usually at random or on a "first-in, first-out" basis).
The assigned customer is then obligated to either deliver 100 shares per contract (for a call) or buy 100 shares per contract (for a put). This is his only choice, i.e., it is too late at that point to go into the market and buy the option back to close his position. Once this transaction takes place and the terms of the option have been satisfied, the option position is closed.
It is important to realize that, as an option writer, you are always at risk of being assigned. In most cases, if your option remains out of the money (the option's strike price is above the stock's market price for a call or below the stock price for a put), the risk of assignment is greatly reduced. But if your option is in the money, the risk is very real and is, in fact, almost certain at expiration. Of course, an option seller always has the choice of buying back the option at any time ... but only before the assignment is made.
Thanks for your question and good luck with your trading!
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Question Level Key
Level One--Basic Jargon, Definitions, Basic Mechanics of Trading.
Level Two--Introductory Points, Practical Points and Simple Strategies
Level Three--More Advanced Strategies and Repairs
Level Four--Risk Management, Psychology, and How Best to Evaluate Things.
Level Five--High end questions concerning Portfolio Analysis, Managing a Portfolio
of Options, Option Pricing Models, and Nuances of Trading. Included could be a variety of
other topics.
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