The moment of assignment and early exercise
You sold a call option on a stock you own. It was supposed to be a nice way to earn some extra "rent" on your shares. But, all of a sudden, the stock price soared and now the option strike price is less than the current price, making it in-the-money (ITM).
Just like that, the abstract world of options contracts becomes very real. So, what happens now?
While buying an option is as simple as a few taps on your phone or clicks of a mouse, the back-end mechanics of assignment and exercise can seem like a mystery.
But, much like that hottie you’d swiped right on, options assignment and exercise aren’t as mysterious as they seem. Here’s your look behind the curtain.
Assignment vs. exercise: two sides of the same coin
In every options trade, there are two parties — the buyer and the seller:
Party 1 - the buyer. The person with the right.
Party 2 - the seller. The person with the obligation.
When the buyer decides to use their rights or the seller has to meet their obligations is where exercise and assignment come in.
Exercise: Exercise happens when the buyer (long position) chooses to make a move and enforce the contract. For example, if you bought a call and the stock is soaring, you might choose to "exercise" your right to buy those shares at the strike price.
Assignment: Assignment happens when the seller (short position) is obligated to fulfill the contract being exercised by the buyer. For example, if you sold a call, and the buyer decides to exercise, you’re "assigned." You have to deliver those shares now.
An easy way to think of it is like a restaurant. The customer (buyer) chooses to exercise their right to order the daily special. The kitchen (seller) is then assigned the duty of cooking it.
The journey of an assignment
When a buyer decides to exercise, the request doesn’t go directly to you. It follows a very specific but randomized path:
Step 1: The buyer tells their broker that they want to exercise the option.
Step 2: The clearing house (either the Canadian Derivatives Clearing Corporation for Canadian ones or the Options Clearing Corporation for US trades) receives the request.
Step 3: Using a random selection process, the clearing house picks a broker with clients that have short positions of the same option.
Step 4: The broker then also uses a random selection process to pick which client gets assigned.
It’s a bit like a lottery. If you sold the same call as 1,000 other people, but only 100 people got assigned you might be one of the "lucky" ones.
But it’s important to know that there are different styles of options which impacts how they’re exercised and assigned.
American vs. European style
Most stock and ETF options in North America are "American style."
This means they can be exercised or assigned at any time before they expire.
"European style" options (usually found on big indices like the S&P 500) can only be exercised on the very last day.
What happens at expiration?
Most of the time, the drama happens right at the finish line.
There’s a common standard called "automatic exercise." This means if an option is $0.01 or more in-the-money at the closing bell on the expiry date, it’s usually exercised automatically by the clearing house.
For the buyer (long)
If your option is ITM, your broker will automatically buy (for a call) or sell (for a put) the shares for you.
But there’s a catch! You need the cash or the shares ready. For example, if you don't have the buying power to handle 100 shares of a $200 stock you might run into margin issues. Your broker might sell the option on your behalf before the market closes to prevent a massive headache.
If you don’t want your broker to take action on your behalf you typically need to give them specific instructions not to.
For the seller (short)
If the option you sold is ITM, expect to be assigned.
On the other hand, if the stock stays below your strike price (for a call), the option expires worthless. You keep the premium, and nothing else happens. You won the trade!
Pin risk: the danger zone
"Pin risk" happens when a stock closes exactly at — or incredibly close to — the strike price at 4:00 PM on Friday. When this happens, you don't know if you'll be assigned or not.
If the stock moves $0.05 in after-hours trading, a buyer might still decide to exercise and you could wake up Monday morning with a "surprise" stock position you didn't expect.
The new speed of money: T+1 settlement
As of May 2024, Canada and the US moved to T+1 settlement for stocks. This means that when you buy or sell a stock, the ownership and the cash change hands just one business day later.
How this affects you
Options have always settled T+1. But, the shares resulting from an assignment used to take two days (T+2) to settle.
Now, everything moves at the same speed. So, if you’re assigned on a Friday, the resulting share trade settles on Monday (assuming there’s no holidays).
This creates a much smaller window. Before, you had until Tuesday to "fix" a cash shortfall or deposit shares. Now, the window is tighter. You need your house in order by Monday morning.
Early exercise: why does it happen?
Most assignments happen at expiration, but there is the odd instance where they don’t.
Why would someone exercise early? It’s usually due to one of these main reasons:
Deep ITM puts: If a put is deep in-the-money, the buyer might exercise early to get their cash immediately.
Dividends: This is the most common reason for an early assignment on calls.
The ex-dividend trap
If you’ve sold a covered call, make sure to keep a close eye on the ex-dividend date.
Call buyers often exercise ITM calls just before this date so they can own the shares in time to collect the dividend payment.
If you’re short a call option that’s ITM, approaching an ex-dividend date, your risk of early assignment increases significantly.
If you’re assigned early:
You sell your shares at the strike price. The buyer gets the dividend; you do not.
If you didn't actually own the shares (a "naked" call), you might find yourself "short" the stock. This means you actually owe the dividend to the person you borrowed the shares from.
Traders who want to avoid this usually "roll" their position (closing the current one and opening a new one further out) or simply close the trade before the ex-dividend date.
Tax implications for Canadian traders
When it comes to tax time, it’s always best to consult a tax professional for accurate advice. But as a general rule (this is not advice), the CRA treats the money you’ve made from options by looking at your intent.
Capital gains. If you’re an occasional investor, options are usually treated as capital gains. That means only 50% is taxable.
Business income. If you’re trading daily, using high leverage, or spending the whole day staring at charts, the CRA might view this as business income. That means it’s 100% taxable.
The math of assignment
When you’re assigned, the premium you originally received isn't taxed as a separate "win." Instead, it’s folded into the cost of the shares.
Scenario | CRA formula |
|---|---|
| Assigned on a put. You buy shares: The premium you received lowers your ACB of the shares you just bought. | $ACB = Strike Price - Premium Received + Commissions |
| Assigned on a call. You sell shares: The premium you received increases your proceeds. | $Proceeds = Strike Price + Premium Received - Commissions |
| Exercising a call. You buy shares: The premium you paid is added to the ACB of the shares you got. | $ACB = Strike Price + Premium Paid + Commissions |
Note: ACB stands for adjusted cost base — it’s the "official" price you paid for tax purposes
