Option Exercise & Assignment
People that sell options have to deal with option exercise risk. When you have sold options that are in the money some one can decide to use his right.
You have better chances of making profit when you sell options than rather buying. With selling options you receive option premium. The buyer has only a limited time to exercise his right. If the buyer does not use it right the option will expire, and you keep the option premium or the credit received.
Once you have sold an option, there is a possibility for the option writer that you got assigned. The trader has to fulfil his obligation to buy or sell shares of the underlying stock. There are two kind of styles though the American or the European style.
American Style vs European Style
American style options can be exercised any time before the expiration date. European style options on the other hand can only be exercised on the expiration date itself. Currently, all of the stock options traded in the marketplaces are American-Style options.
When an option is exercised by the option holder, the option writer will be assigned the obligation to deliver the terms of the options contract.
Assignment takes place when the written option is exercised by the options buyer. The options writer is said to be assigned the obligation to deliver the terms of the options contract.
If a call option is assigned, the options writer will have to sell the obligated quantity of the underlying security at the strike price.
If a put option is assigned, the options writer will have to buy the obligated quantity of the underlying security at the strike price.
One can never tell if an will take place. To ensure a fair distribution of assignments, the Options Clearing Corporation uses a random procedure to assign exercise notices. In turn, the assigned firm must allocate those notices to accounts which have the short positions on those options.
Options are usually exercised when they get closer to expiration. The reason is that it does not make much sense to exercise an option when there is still time value left. Its more profitable to sell the option instead.
Over the years, only about 17% of options have been exercised. However, it does not mean that only 17% of your short options will be exercised. Many of those options that were not exercised were probably out of the money to begin with and had expired worthless. In any case, at any point in time, the deeper into-the-money the short options, the more likely they will be exercised.