Assignment

When an option holder exercises, somebody has to be on the other side of it. Assignment is the process of deciding who.

The workbook's definition is exactly one sentence: assignment of options means the allocation of exercised options to one or more option sellers. The buyer chooses to exercise. The seller does not choose anything — he is allocated.

That asymmetry is the whole of the writer's position. He took a premium up front in exchange for an obligation, and assignment is the day the obligation is called in. The workbook's warning to writers is blunt: all option writers should be aware that assignment is a distinct possibility.

In India the timing is settled by the exercise style. All exchange-traded index and stock options in India are European, so buyers can exercise only at maturity, and therefore exercise and assignment are permitted only on the expiration date.

The rest follows mechanically:

• There is no daily settlement of option contracts the way there is for futures. Only the seller pays mark-to-market margin along the way.
• Options are exercised against the settlement value — the closing price of the relevant index or stock in the cash segment on the last trading day of the contract.
• Index options are cash settled: the holder of an in-the-money long receives the difference between the strike and the closing index value, and the assigned writer pays it.

Against an American-style option — which India does not list on index or stock underlyings — assignment can arrive any time during the life of the contract, which is why the workbook flags it as a risk the writer must live with rather than plan around.

Assignment is also why the writer posts margin and the buyer does not. The buyer's liability ended when he paid the premium; the writer's has not started.

Call writer assigned:  Pays (Settlement price − Strike) × Lot size
Put writer assigned:   Pays (Strike − Settlement price) × Lot size

Net position = Premium received − Amount paid on assignment

Settlement price = closing price of the underlying in the cash segment
                   on the last trading day

A trader writes one lot of the 17,500 call for Rs 95, contract size 50.

Premium received = 95 × 50 = Rs 4,750
Break-even       = 17,500 + 95 = 17,595

The index closes at 17,400 on expiry. The call is out of the money, nobody exercises, no assignment happens. He keeps the full Rs 4,750 and the contract disappears.

The index closes at 18,000 instead.

Assigned on           = 18,000 − 17,500 = 500 points
Paid out              = 500 × 50 = Rs 25,000
Less premium retained = Rs  4,750
                        ──────────
Net loss                Rs 20,250

Rs 20,250 lost on a contract that paid Rs 4,750 to open — and nothing capped it. Had the index closed at 19,000, assignment would have cost Rs 75,000 against the same Rs 4,750.

Now the part candidates miss. The writer never got a decision. He could not decline, could not choose a settlement price, could not deliver something else. On the morning of expiry his position was worth whatever the cash market printed at the close, and the clearing system allocated the consequence to him.

That is why the exchange takes margin from him throughout, and takes none at all from the buyer of the same contract: the buyer's maximum liability was paid on day one; the writer's has no ceiling and no date of his choosing.

Chapter 16.1 defines assignment and the European exercise style that governs its timing in India; Chapter 16.2 gives the final settlement price as the cash-segment closing price; Chapter 16.5 carries the warning to writers. Expect a question on when an Indian index option can be exercised — only on the expiry date — and on who bears the obligation.

• Exercise is the buyer's act; assignment is what happens to the seller. They are two ends of one event, and the words are not interchangeable.
• All Indian exchange-traded index and stock options are European, so assignment before expiry cannot occur on them.
• Only the writer pays mark-to-market margin. Option contracts have no daily settlement for the buyer at all.
• Settlement uses the cash-segment closing price, not the futures price and not the last traded option price.
• Assignment is allocated, not negotiated. The writer has no say in whether or when.
• A covered call writer is assigned too — he simply already holds the shares to deliver, which is what makes it "covered".