Assignment in Finance: Definition, Mechanics, and Examples

Explore the concept of assignment in finance, including its definition, mechanics, and practical examples, particularly in the context of options trading.

Definition

An assignment in finance often refers to the transfer of rights or property. This broad definition encompasses various contexts, but in the realm of financial markets, it specifically pertains to the process where an options writer is notified that their written option has been exercised by the holder.

Types of Assignment

• Transfer of Property Rights:

  • This involves legally transferring ownership or rights over a financial asset or property from one party to another.

• Options Assignment:

  • In options trading, an assignment is the notification received by an option writer indicating that the option buyer has exercised the right to buy (call option) or sell (put option) the underlying asset.

Mechanics of an Options Assignment

When an option is exercised, the following steps usually take place:

• Exercise Notice:

  • The options holder informs their broker to exercise the option.

• Broker Notification:

  • The broker then communicates this to the clearinghouse.

• Assignment Notification:

  • The clearinghouse randomly selects an option writer whose contract is assigned and informs their broker.

• Action by Writer:

  • The writer is then required to fulfil the obligation – either buying or selling the underlying asset at the strike price.

Special Considerations

• Exercising American vs. European Options:

  • American options can be exercised at any time before expiration, increasing the likelihood of assignment.
  • European options can only be exercised at expiration, limiting the timing of potential assignments.

• Premium Receipts:

  • Option writers receive premiums upon selling options, which can affect their potential profit/loss when an assignment occurs.

Examples of Assignment

Example 1: Call Option Assignment

Suppose an investor wrote a call option with a strike price of $50. If the market price of the underlying stock rises to $60, the option holder may decide to exercise the option. The writer must then sell the stock at $50, potentially incurring a loss if they do not own the stock.

Example 2: Put Option Assignment

An investor wrote a put option with a strike price of $40. If the stock falls to $30, the option holder may exercise the option. The writer must buy the stock at $40, leading to possible losses if the stock’s market value remains low.

Related Terms

• Options Writer:

  • The party that sells the option contract and is subject to assignment upon exercise.

• Options Holder:

  • The party that buys the option contract and holds the right to exercise it.

• Strike Price:

  • The predetermined price at which the option holder can buy (call) or sell (put) the underlying asset.

FAQs

What is an assignment in options trading?

An assignment in options trading is the process where the writer of an option contract is notified that the buyer has exercised their right, thus obligating the writer to fulfill the contract terms.

Can an assignment result in a loss?

Yes, depending on the market conditions and the strike price, an assignment can result in significant losses for the options writer.

How can an options writer avoid assignment?

To avoid assignment, an options writer can close their position by buying back the option before it gets exercised, although this may also incur a cost.

References

• Hull, J. (2017). Options, Futures, and Other Derivatives. Pearson Education.
• McMillan, L. (2002). Options as a Strategic Investment. New York Institute of Finance.

Summary

An assignment in finance broadly refers to the transfer of rights. In the context of financial markets, particularly options trading, it denotes the process of an options writer being notified that their option has been exercised. Understanding the mechanics, implications, and potential risks associated with assignments is critical for anyone involved in options writing or trading.