Option early assignments due to stock dividends

Recently, I received a broker’s email regarding possible early assignments for my option positions on TLT which was approaching Ex-dividend date in two days. So I studied option early assignments for option sellers due to dividends.

First, here are the major dividend dates and events.

1. Declaration Date - date at which company approves dividend payment and designates the Payment Date and Record Date.

2. Ex-Dividend Date - the date on or after which the stock will be traded without the right to receive the dividend. The Ex-Dividend Date is two business days before the Record Date.

Call option early assignment dates are usually one or a few days before this Ex-dividend date. Put option early assignments usually happen on the Ex-dividend date.

3. Record Date - the date which determines which stockholders are entitled to receive the dividend payment. They have to own the (settled) shares as of the close of this date in order to receive the dividend. Because most stock trades in the US settle three business days after the trade, a trader must purchase the stock three business days before the Record Date to qualify for the dividend.

4. Payment Date - the date on which the declared dividend is paid to all stockholders owning shares on the record date.

Next, let’s take a look what kind of and when options are susceptible for early assignments.

The owner of the call often exercises certain type of call options at the strike price of the call, one the day before the stock goes ex-dividend, to receive the dividend, if the call option is in the money and the amount of the dividend exceeds the remaining time value of the call. As an option seller, the trader may get early assignment as a result of exercises of the call buyer.

For short puts, early assignment usually occurs exactly on the ex-dividend date, when those puts go in the money and expiration is a few days out or less (not much time value left). This happens when the long protective put holders who also own the stock can remain as the shareholder of record to receive the dividend on payment since they own the stock before the Ex-dividend date, and possibly benefit from the stock price drop at the opening of the ex-dividend date caused by the dividend. On the morning of the ex-dividend date, the opening price of the stock is reduced by the amount of the dividend. After the put exercise, the trader can receive cash and earn interests as well. Note exercising a put option on the day before an ex-dividend date means the put owner will have to pay the dividend.

Early assignment occurs when an option holder exercises his option by notifying his broker, who then notifies the Options Clearing Corporation (OCC). The OCC fulfills the contract, then selects, randomly, a member firm who was short the same option contract. The OCC then notifies the firm. The firm then carries out its obligation, and then selects a customer, either randomly, first-in, first-out, or some other equitable method who was short the option, for assignment. That customer is assigned the exercise requiring him to fulfill the obligation that he agreed to when he wrote the option.

Early assignment’s impact for covered call positions

For a covered call seller, it means the seller will not only unexpectedly lose the stock position, but also the next dividend payment. The early assignment forces the call seller to sell the stock in order to fulfill the obligation of the short call.