Stocks & Commodities V. 25:3 (49): Explore Your Options by Tom Gentile

Stocks & Commodities V. 25:3 (49): Explore Your Options by Tom Gentile

Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it to our website at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.

EARLY ASSIGNMENT ON CREDIT SPREADS

After a credit spread on equities is executed, is there a risk of early assignment on the short leg if extrinsic value goes below $0.20? Before execution, if the short leg of a credit spread has an extrinsic value of $0.20 or less, will it ever be executed? I know there is no early assignment on calls/puts on European-style indexes. I’d appreciate your advice. —Paul

You are correct that options with the European-style settlement feature do not carry any early-assignment risk because exercise and assignment can only happen at expiration. Most (but not all) index options settle European-style and can only be exercised at expiration.

Stock options settle American-style and, as a result, exercise and assignment can happen any time prior to expiration. But it isn’t likely that an option with time value will be exercised, because the option owner would lose or sacrifice that time value if they exercise the contract. They would be leaving money on the table. When time value remains, it is usually better to sell the option to close the position rather than exercise it.