To this point we have defined options using the first three points below. Now we add to this definition when this takes place.
- The right or obligation
- To buy or sell
- If the price of the underlying security is through the strike price (in the money)
- At– and sometimes before — expiration
There are two types of exercise and assignment which define if exercise and assignment can happen only at expiration or if exercise and assignment are allowed prior to expiration.
- American options: may be exercised anytime before expiration as long as the underlying security is ITM.
- European options: may only be exercised at expiration
Here is a general description of the markets that have different exercise and assignment styles.
- Stocks and ETFs are all American style options.
- Some indexes are American style options.
- Options on Futures contracts are a mix of American and European style.
- Most of the actively traded indexes are European style options.
Here’s a device to help you remember which style allows for early exercise and assignment: America is younger than Europe; so America has been around for a shorter amount of time. You can think about American style options as having the potential to be held for a shorter amount of time until they are exercised.
The specific issue with this is that sellers of American style options may be subject to assignment prior to expiration — which changes their portfolio earlier than expected.
An early assignment is rare, except for short calls where the underlying stock is due to pay a dividend. Long call holders will often exercise their option in order to collect the dividend.
A final note on exercise and assignment: Pairing the parties who will exchange the underlying is done by a random process. Not first in first out or any other specific method.