The Question of Assignment

I will cover this issue in detail here, so as to demystify the assignment of short options. My discussion may appear complicated, but I assure you it is not. My intention is to comprehensively cover your alternatives and to view assignment the way I see it. I see assignment is as a minor inconvenience that is easy to handle, when it comes to the PCCRC.

In more basic credit spreads, assignment would mean that your spread is ruined. For example if you had a 35/40 Bull Put Spread in MSFT, your short is now deep in the money, and as we approach Feb expiration, you may end up with long stock at $40. In that situation, you could exercise the long put, and end of story.

With the PCCRC is a little different. My PCCRC in MSFT at $35 has a Feb $35 short put, and as we approach Feb expiration and the stock being at $30/share, it's becoming susceptible to assignment. A quick scan through your positions should make you aware of this possibility, starting 10 days before expiration. You can easily prevent assignment by doing an early rollover of positions that you want to keep, but that are deep in the money.

I have said that the PCCRC should give you the freedom to travel because is not a short-term trade, not even a swing trade, but rather an intermediate term trade that should he held for 2-3 months, or more. To go on a 10 day trip could be hazardous to your account if you do not have sufficient cash to handle any potential assignments. What would happen? if you are assigned and now have stock instead of a short put, you are fine, as long as there is enough cash to cover the long stock position. It is truly equivalent to the short put, at least in the short term. But if you are like me, you want to put your capital to work, and not let it sit around just to cover a potential long stock position. So before you go on your trip, and regardless of how close to expiration you are, rollover your shorts. If you don't think it is worth doing the rollover, then close your position. The way I see it is that not every position is worth keeping, and when I travel, I understand that my performance is not going to be the same, but I know that with the PCCRC I have peace of mind, and that when I come back I can actually have profits.

Early last year I had an account with Interactive Brokers, which had several PCCRC's as I went on a 10 day trip to Perú. If you go to third world countries (like I love to do), you may not have access to the internet. Taking your lap top makes no sense. However, I was able to use the Hotel's internet service while in Cusco, early in the morning. As it turns out, I had been assigned short stock (which is unusual - more on this below). I was only able to get to the computer about 20 min after the market opened. Interactive brokers had arbitrarily closed my most profitable PCCRC (on AAPL I remember well), in lieu of my assigned short stock. In panic, I close that position too. I over-reacted, but Interactive Broker's policy of liquidating positions at random right after the opening did not help at all. I tell you this so you know that interactive brokers is not PCCRC-friendly, and that when traveling, you can avoid this problem by closing positions that are deep in the money, or roll them over to the following month. Also, know that TOS gives you the whole day for you to figure out what you want to do. There are several alternatives to what to do when assigned, base on the performance of your PCCRC, which should really be the only consideration. Assignment should NOT be the traumatic experience I had in Cusco.

1. Close the stock position (short or long, whatever that may be) and reopen your short. Same strike price, same expiration. If you do this, you may be assigned again the next day. Although in theory, this keeps the position exactly as it was before assignment, you'd be just play a game and you'd slowly lose in commissions and slippage. So don't do this one.

2. Close the stock position and reopen the short but at the next expiration month. This assumes that you want to continue in the trade. You have now extended the life of your trade for one more month, and you are much less likely to be assigned because the buyer of your short is not going to give up the time value so easily. However, you should consider that you were assigned because the stock has move strongly in either direction, so you should have some profit already. If you have no profit, then the more serious question would be, why would I continue on a losing trade for one more month. Volatility may be low enough so that the difference between the stock price and the strike price is very close to the value of your shorts. In other words, there is little or no premium to be had by shorting again. So consider this alternative carefully. Take it as an opportunity to examine the trade critically, and decide if it is worthy of more of your time an effort.

3. Close the stock position and SELL an equivalent number of your long contracts. This is probably the best alternative, since it could slowly and progressively unwind your position. Let's say you have a -5c,-5p,+10c,+10p in MSFT at $35 strike price with Feb/May expirations, respectively. After the MSFT deal with Yahoo was announced, the stock begun to decline despite dissent earnings. Volatility, despite the drop in stock price is fairly low, so my profit is fairly marginal. Then this morning I am assigned 300 shares of stock and 3 of my shorts have disappeared. I decided that MSFT is not going to go down much further, and that the low IV is not favorable for me to continue on to next month. I could simply SELL 3 the stock and immediately thereafter, sell 3 of my long puts. This would leave me with -2p, and +7p, which is actually more bearish that the original position. It would even be OK to sell 4 or 5 or up to 8 of my long puts, depending on how bearish I feel. Unwinding my position in this way is not a bad idea, as you will not pile up commissions, and you may be taking a small profit or a small loss as you go.

In many ways, the PCCRC is self-limiting, and instead of having stops, there are critical points at which you should ask yourself whether is worth keeping the trade or closing it. Being assigned is one of those times. In the case of MSFT, the low IV is the main reason why I may be assigned. This is common when you trade PCCRC with blue chips (Dow components). If you stick to momentum stocks, assignment is less probable because IV is usually high in these stocks.

I said that being assigned short stock is unusual. This is because it would only happen when the stock has moved strongly higher, and your short calls are now deep in the money. Even still, your option should have sufficient volatility to cause the extrinsic value of the option to be significant. Since that episode in Perú, I have not been assigned short stock. In fact, I rarely get assigned much at all. Doing my rollovers 10-7 days before expiration goes a long way to prevent assignment. But viewing assignment as an opportunity to critically examine your trade and exit with a small loss or small profit may be a blessing.... Consider that next time you are assigned.

Finally, Think or Swim offers you a feature that should help you deal with assignment in an elegant manner. You'll find that Stocks have a much narrow bid/ask spread than options do. So it makes sense to fill the option first, at a limit price. It really matters little what price the option is at when you place your trade, but make sure that the limit is favorable to you, understand that you have all day to close your long or open a new short (whatever of the 3 options you decide to do), Place a 1 trigger's sequence order to close the stock position at market once the option order is filled. This makes sure that the nature of the trade is not changed by the adjustment, living you with the burden to close the stock position at a good price.