Options 101 · Module 9 of 10

Exercise, assignment, early exercise, pin risk

In this lesson

Explain what exercise and assignment do to your position, the automatic-exercise rule at expiration, when early exercise tends to happen, and pin risk.

5
short parts
11
questions
~15
minutes
Read the whole lesson on one page

Exercise, assignment, early exercise, pin risk: the lesson

Exercise and assignment

Exercise is the buyer using the right. Assignment is the seller being told to deliver.

Exercise (the buyer)Assignment (the seller)
A call holder buys 100 shares at the strikeA call seller must sell 100 shares at the strike
A put holder sells 100 shares at the strikeA put seller must buy 100 shares at the strike

What happens at expiration

  1. Step 1: You hold a long 40 call. The stock closes at 42.
  2. Step 2: It's $0.01 or more in the money, so it's exercised automatically unless you say no.
  3. Step 3: On Monday you hold 100 shares, bought at $40, a $4,000 charge.
  4. Step 4: An option that closes out of the money, like a 40 call with the stock at 38, is not exercised. It expires worthless.

Early exercise

US stock options can be exercised any business day, so a short option can be assigned early. The classic case is a call just before an ex-dividend date. The holder exercises to get the dividend when it beats the call's remaining extrinsic value.

Sell the callExercise the call
With the stock at 60 and a 50 call at 10.60: you get 10.60You get 10.00 of value
Keeps the 0.60 of extrinsic valueGives it up

Pin risk

Pin risk is the uncertainty when the stock closes right at your short strike. Walk through it with the 50/55 bull call spread, with the stock closing at 55.00.

  1. Step 1: The stock closes at 55.00, exactly at the strike of your short 55 call.
  2. Step 2: Your long 50 call is 5.00 in the money, so it is exercised automatically. You are set to buy 100 shares at $50.
  3. Step 3: Your short 55 call has no value at 55.00, so the holder may or may not exercise it. The choice is theirs.
  4. Step 4: If it is assigned, you sell 100 shares at $55 and the shares net to zero. If it isn't, you keep the 100 shares you bought at $50.
  5. Step 5: You won't know which until after the close, and after-hours news can move the stock before Monday.

If your short leg is assigned

  1. Step 1: You hold a 50/55 bull call spread and the short 55 call is assigned early.
  2. Step 2: You're now short 100 shares, and you still hold the long 50 call.
  3. Step 3: You can exercise the 50 call to buy 100 at $50 and cover. The loss stays bounded.

Worked example: A 50/55 bull call spread held to the close

Illustrative numbers, not real quotes.

You hold the 50/55 bull call spread from Module 7, bought for a 1.42 debit, through the 4:00 PM close. Here is what happens to the shares in your account:

Stock at the closeLong 50 callShort 55 callShares in your account Monday
48ExpiresExpires0 (you lose the $142 debit)
52Auto-exercisedExpires+100, bought at $50
55.02Auto-exercisedProbably assigned, not certain (pin risk)0 if assigned, +100 if not
57Auto-exercisedAssigned0
  • Stock at 57: you buy 100 at $50 and sell 100 at $55. That is +$500 from the legs, minus the 1.42 debit = +$358, the max gain. Selling the spread at 5.00 before the close gives the same result.
  • Stock at 54.90 at the close, then it drops after hours: the long 50 call is exercised, and the short 55 call is out of the money, so it is likely not assigned. You now own 100 shares ($5,000) over the weekend. If that is more than your account can hold, the broker may step in.
  • This is why people close or roll spreads before expiration.

Education only, not investment advice. Options involve risk. Read the OCC's Characteristics and Risks of Standardized Options. Example numbers are illustrative.