Strategies

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Covered Calls

 

Assignment before expiration

Before a Dividend

Because the holder of any equity option has the right to exercise the contract before the option expires, so may the writer of an equity call contract be assigned at any time before expiration. However, early assignment on a short call can most likely be expected before the underlying stock pays a dividend, the call is in-the-money, and the time premium amount of the call's market value is less than the dividend amount.

If early assignment before a dividend occurs, the ZYX 45 call writer is obligated to sell the 100 underlying shares at the $45 strike price, just as when the call expires in-the-money at expiration and assignment is received. The position's maximum profit may be realized at the expected return, but less the dividend paid to underlying shareholders. And as with assignment on a covered call at expiration, the investor will then have no position - no short call and no 100 shares.

The timing for early exercise of an equity call to receive a dividend paid to underlying shareholders is critical. A call holder must exercise a call contract no later than the day before the ex-dividend date in order to purchase underlying shares and be eligible for dividend payment. Therefore, you might expect notification of a possible early assignment on the ex-dividend date itself. For this reason, any covered equity call writer should be aware of an expected dividend amount and the timing of its payment.

 
 

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