Assignment Risk And How To Manage It
Assignment risk is an important concept to understand but nothing that you need to freak out over. When you follow the rules taught in this program, you will make virtually impossible to experience any assignment risk. Assignment risk can happen at two different time periods: expiration or early assignment.
Expiration Assignment Risk is the most common assignment risk. It occurs when one or both of your credit spread options are in the money at market close on expiration day.
- If the short option is in the money at expiration, your short option will be assigned while your long option will expire worthless. If this happens, you will need to get rid of the shares the next trade day if the broker doesn't do it for you automatically. Your loss in this situation is based on far the stock is from the strike price of the short option that got executed. This risk can be avoided by following our Expiration Day Exit Rule which states that if a credit spread is close to the short strike on expiration day, you must close the trade before the market closes.
- If the short option and the long option are both in the money at expiration, then you will experience the max loss listed by the broker when you first entered the position. This is because your short option will get executed but your long option will also get executed and protect the short position. This also means there is no assignment risk in this situation.
The Early Assignment Risk is the least common assignment risk. It occurs when a credit spread trade is deep in the money and the holder of the option wants to execute the trade early. This is typically only common for call credit spreads near the ex-dividend date. This is because the call option holder wants to covert their option into shares so that they can receive the dividend. However, this is only likely to happen if the option is trading in the money. If this happens, you can manage risk by simply executing your protective option if it's also in the money or buy closing out the shares position as quickly as you can. The loss will be very minimal because you have your protective option that is still active and tradable.
However, you virtually eliminate assignment when you follow our Sell When Strike Is Broken exit rule. This is because assignment risk comes when your options are in the money, but if you exit the trade before you allow your position to be in the money, then your risk goes away.