When to Expect Early Assignment

American style options, unlike European style, may be exercised at any moment in their lifetime. Stock options are American style and it's good to know when an option is likely to be exercised ahead of its expiration. This is of particular importance if you are short these options.

When thinking about calls they are unlikely to be exercised early unless a dividend is about to be paid. Remember, dividends are paid only to shareholders and not options owners no matter how deep in the money that option may be.

The option specification may say that the call expires on the third Friday of the month, but if a dividend is going to be paid 10 days before that all deep in the money (ITM) calls are almost certainly going to be exercised the day before the dividend is going to be paid. If you own the stock against a short call you will likely lose your stock before the dividend is paid. And if are short an ITM call against other calls in a spread you are going to end up being short the stock. People who are short the stock over the dividend must pay that dividend to the short stock lender.

Therefore, it is vital that the investor is always aware of what the dividend is and when it will be paid.

As for puts, a deep ITM put is likely to be exercised if it is unlikely the stock will rise above the strike price or if the call at that strike is trading under what you have to pay in interest to carry the stock. This cost is called the "cost of carry".

Allow me to illustrate. Let's say that XYZ is trading at 100 and I own the stock and I own the 150 put. The only way that position will make money, barring a dividend, is if the stock goes above 150 before expiration. If I think that is highly unlikely I will exercise the put, "put my stock away", as it were, and free up the money.

Let's say that it costs me .20 in interest to carry the stock to expiration. Keeping in mind that the only way the position makes money is if XYZ goes above 150. If I can buy the 150 call for less than the cost of carry I will do that and exercise my long put.

Therefore, if you are short a deep ITM put, perhaps as a stock substitute, always be aware of what the cost of carry until expiration is and when the call trades under that price expect early assignment.

In conclusion, being short deep ITM options requires careful monitoring of both the dividend and the cost of carry until expiration.