This segment is about early exercise and how to tell when, as a premium seller, you are at risk of an early exercise, including important information about the role of dividends. All premium sellers need to know this information.
Understanding the extrinsic value in an option is the key to understanding your risk of an early exercise. A trader who is long an option and exercises it forfeits the extrinsic value. If there is enough extrinsic value no smart trader will exercise the option.
An option that is barely in the money will have mostly extrinsic value. The deeper it goes in the money the more it will gain in intrinsic value and lose in extrinsic value. A deep in the money option with not much time remaining will trade almost like the underlying.
Dividend risk is the risk of early assignment when a stock goes ex-dividend. Dividend risk only applies to short ITM calls, as long call holders may exercise their option to collect the dividend. If the dividend is greater than the price of the put at the same strike of your short call you are at risk. Thi is because a risk free profit can be captured since the put is essentially being purchased for a credit.
An example of a $0.16 dividend on August 3, 2015 was displayed. The example showed the stock price, August put strike and option price. A table was displayed of different dividend amounts and put prices. The table showed the dividend, value of the put, theoretical arbitrage P/L and assignment risk on short calls at put strike.
An important point was made about dividends and ETFs. Dividend paying stocks usually have dividends that are known well in advance. ETFs pay dividends which change from quarter to quarter (or month to month). This is another important risk factor to consider.
Watch this segment of “Options Jive” with Tom Sosnoff and Tony Battista for the takeaways and to learn how to gauge early assignment risk.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.