Early Assignment on Short Calls — Step-by-Step Guide & Transcript

[00:01] ways you can help us out by liking the video or subscribing to the channel. Either one of those guys really helps us out a lot. So, it happens to every single trader at one time or another. You wake up, you check your portfolio,

[00:15] and all of a sudden your short call is gone. Like all of a sudden your short call that you had on just the previous day is now gone. It's been replaced by short 100 shares, and you're trying to figure out what happened. This can be a

[00:27] very startling experience, sometimes even a bit of frightening the first time or two or 13 that it happens to you when you are assigned on a position and you weren't necessarily expecting it. And for a lot of traders, early assignment

[00:41] can kind of feel like a glitch in the matrix. It can kind of feel like, man, something went wrong in the process. But actually, a lot of times it's purely mechanical. Like a lot of times it really boils down to the dividend risk

[00:54] that might exist in the marketplace up against the extrinsic value that you have in that short call, and that's what I want to break down here today. So, understand is that when it comes to assignment risk as it relates to

[01:06] dividends at least, this is a short call problem. This is not a short put problem. We understand this better by just looking at the other side of the contract. All right, remember when we are assigned, that means the other side

[01:18] exercised that contract. That means the call buyer decided to exercise because they want to be long the shares, so that means the put buyer decided to exercise because they want to be short the shares. Well, if we're talking about

[01:30] to be the shareholders that get to collect the dividend. In fact, anyone that's actually short the shares when the dividend comes out has to actually pay that dividend. So, this is not going to apply to the put side of the options

[01:44] market. This is going to be a call only phenomenon because when a company is about to pay a dividend, the long call holder has to decide, okay, what is going to be a better economic move for me? Should I keep my option and sell my

[01:57] option and collect that extrinsic value or should I consider exercising the option and capturing the dividend? That's what we're going to break down And at the end of the day, it's actually fairly simple. Like we're going to go

[02:09] second and then go through a real-life example in the markets in just a minute. very simple. If the extrinsic value in the option is greater than the upcoming dividend, then that kind of moves the decision point towards, all right, I

[02:24] should probably keep the option and sell the option if I want to get out of the position because I'm going to make more. The extrinsic value is greater than the dividend, so let me capture the extrinsic value and forgo the dividend.

[02:36] Of course, if the opposite were true and the reverse were the scenario, now the dividend is greater than the extrinsic value, now it maybe makes a lot more sense to exercise the option, take the shares, and capture that dividend. I'm

[02:48] foregoing the extrinsic value, but it's a better economic move for me in the end let's put some numbers on it. Let's say that you are short a 100 strike call on a stock that's selling for 102. So, it's in the money by a couple of dollars. It

[03:02] has a dividend coming up of a dollar 50. And let's say you're trying to figure out, what is the likelihood that I get assigned on this short call that is in the money, that is giving the long side some intrinsic value, but I'm trying to

[03:14] weigh the probabilities that I actually take assignment on this position. Okay. Let's say the extrinsic value in your call option, in your 100 strike call, is 60 cents, let's say. In this scenario, the extrinsic value is only 60 cents,

[03:28] the dividend is a dollar 50. So, from the long call's vantage point, it makes a whole lot more sense to exercise the option, capture the intrinsic value, take the shares, and also capture the dividend. You give up the 60 cents of

[03:42] exercise, you only get the intrinsic value, but still, you're picking up the dividend of a dollar 50. So, you lose 60 cents, but you make a dollar 50, net, net, you're up ninety cents. Okay, same scenario, but let's now say

[03:57] that the extrinsic value in the call option was two dollars and fifty cents. Right now, you're looking at the exact same scenario, but now the dividend is a dollar fifty, the extrinsic value in the call is two dollars and fifty cents. So

[04:09] tilted in favor of, "Hey, if I want to get out of this position as a as the long call holder, I'm just going to sell the call. I'm going to sell the call, already in the option price, and the extrinsic value of two fifty, and I

[04:24] forego the dollar fifty dividend." So again, net, net, I come out ahead. I pick up two fifty, I forego a dollar fifty, I come out a dollar ahead. So there's a hypothetical example. Let's now pop into the markets because Pepsi

[04:38] in about the next month, and so we can take a look at that and better understand this phenomenon. Okay, so here I am inside of my tastytrade platform, and I've got Pepsi pulled up. So the first thing that you

[04:50] figure out if a dividend is coming up, is just look at the option chain. Because the option chain is going to show you if there is indeed an upcoming dividend, which you can see right here, uh coming up on September 4th for Pepsi.

[05:04] So right there, the blue line on the option chain tells me this is the ex-dividend day. So this is the day where you need to make a decision about your short call leading up to this day, otherwise, if you go through this day,

[05:18] and you still have that short call on, that's when the assignment risk can really become a lot more likely. So September 4th is the ex-dividend day. check is just go ahead and pull over this right arrow in tastytrade, and

[05:35] bring up the quote overview, the quote details. And what you're going to find is it's going to tell you what the upcoming dividend is anticipated to be. upcoming dividend is anticipated to be. So in this case, it's a dollar 48. So, a

[05:48] dollar 48 dividend from Pepsi. This is the number that I need to focus on when I'm comparing and contrasting with extrinsic value to try to figure out what the likelihood is that my short call that's in the money might be

[06:01] assigned. Okay, so now if I open up an expiration cycle, so let's say I open up September, for example, with 49 days to go. And I'm taking a look at just the in the money calls. These are the only options that

[06:14] I'm concerned with. So, I'm looking at, obviously, these options on the screen. And I want to know where is the extrinsic value of each option and how does that stack up against the dividend that's coming up in Pepsi. And you can

[06:29] see the 120 call that's in the money, this guy only has extrinsic value of 70 to September 4th, you are almost certainly going to be assigned because, again, remember, the long call can pick up a dollar 48 dividend and only forego

[06:44] the 71 71 cent extrinsic value. Similarly, this 125 call also 95 only 95 cents of extrinsic value. So, it is underneath that dollar 48 marker that we

[06:56] just saw. But now, when you get to the 130 call, call, at least as it stands right now, obviously, the markets move and things change and so things aren't going to necessarily stay this way, but the 130

[07:09] call, this guy is actually likely safe from assignment because, again, the long call holder would be more economically benefited from just selling out of the call if he wants to get rid of his

[07:22] position than exercising and picking up the shares. And so, of course, the 135 spot with, it looks like, a little over $3. That yellow line is kind of jamming us up a little bit here, but it's significantly higher than the upcoming

[07:36] assignment risk as it relates to dividends, it all comes back to the extrinsic value. It all comes back to what is the extrinsic value in the dividend, and that tells you everything you need to know.

[07:50] So, assignment is something that's going to happen to every single option trader question, it's going to happen. If it's not happened to you yet, it is coming, I promise you. It's not a question of if, it is a question of when. But again,

[08:02] for and understanding, you know, upcoming dividends, ex-dividend dates, and extrinsic values can give you a much better assessment of the likelihood that I hope that helped. I'll see you guys next time.