Short an option - random assignment?

Question

I'm still really new to options but I'm trying to understand this concept of assignment.

Let’s say I’m short a call of Microsoft at a strike of 80 set to expire in a quarter. Microsoft surges for one day, going up to 86. Someone long a call for the same option exercises early. It’s randomly assigned who has to physically settle with this buyer. And so as an option seller, you can’t guarantee you will hold the option until expiration, and you can be randomly assigned to someone who wants to exercise early? So you're taking the risk that you will be randomly assigned someone long the same option who wants to exercise early? How is this fair, as theoretically different traders short a call for the same strike may receive different profits based on if one is exercised early?

Answer 1

Actually, the process is not completely random. Rather it follows the OCC's assignment procedures:

The broker who is assigned in turn allocates their assignments among their customer accounts according to their own procedures (which could be random allocation, first-in first-out, etc).

You can also look at how much assignment activity is going on by the change in open interest from one day to the next compared with transaction volume. Many participants will also exercise options into order to receive dividends before the stock goes ex-dividend, but as @JoeTaxpayer has pointed out, most people will hold options to expiration.

The OCC have a policy where at expiration, if an option is in-the-money by $0.01 or more, then they will automatically exercise the option, unless they receive "contrary advice" from the holder.

Answer 2

You've described the process fairly well.

It's tough to answer a question that ultimately is 'how is this fair?' It's fair in that it's part of the known risk. And for the fact that it applies to all, pretty equally.

In general, this is not very common. (No, I don't have percents handy, I'm just suggesting from decades of trading it's probably occurring less than 10% of the time). Why? Because there's usually more value to the buyer in simply selling the option and using the proceeds to buy the stock. The option will have 2 components, its intrinsic value ("in the money") and the time premium. It takes the odd combination of low-to-no time premium, but desire of the buyer to own the stock that makes the exercise desirable.

Answer 3

When you sell a covered call, you agree to sell the underlying at a given price in a given period of time. In return, you receive a premium that is yours to keep, no matter what the underlying does. OTOH, the owner of an American option (equities) has the right to exercise his long call at any time. How is this fair? By selling the covered call, you have agreed to these terms.

In terms of frequency, this doesn't happen that often. This is because if there is time premium remaining in the option, it makes more sense to sell it than to exercise it. Per the CBOE, about 7% of options contracts are exercised.

If you don't want to sell your stock, you shouldn't be selling covered calls. If you want to take that chance in return for the premium income and have a better shot of keeping your stock, when your stock nears the short strike (assuming no gap through the short strike), roll your short call up and out for a credit, giving yourself more upside capital gain potential.

From the perspective of a trader seeking income, the sooner the covered call is assigned, the better since the ROI is higher.