All trades have an associated timeframe. In the world of options, the time horizon is never longer than the Expiration Date. This means that you have to be correct, not only on the direction of the market, but also on the direction of the market by a certain time. If you make a wrong call even one week prior to the Expiration Date, you can get assigned stock by your broker or dealer if you’re short an in-the-money contract heading into the expiration. This is called Option Assignment.
The broker or dealer can Short Call into Short Stock and Short Put into Long Stock, as need be. This means that you have unlimited risk potentially associated when trading in long options. Meanwhile, in-the-money puts and calls are subject to auto-exercise at expiration. If not closed, long calls and long puts that are ITM, even by a mere penny, are automatically exercised.
When to close a position
• 5 to 20 days prior to Expiration: You might want to close a position prior to expiration. For example, if you happen to be holding short puts on ‘Google’, you could get assignment shares of Google. If you do not want to own the shares of Google, you can prevent the assignment by closing your options positions, say 5-20 days prior to Expiration Date.
• When Target Gain or Loss is reached: Stick with your Trading Plan and to close your position once Target Gain or Loss is reached. In such cases you have to be proactive and should not wait till Expiration.
• Stock goes against you: You have to close your position if the stock goes against you.
• Tradespoon predictions changes: It is advisable to close the position if the Tradespoon prediction for the position changes, even if you are bullish on the stock. Tradespoon provides you with trade recommendations on a daily basis, which will indicate Uptrend or Downtrend for Options based on Tradespoon’s analytics. But a binary event during the day can change our prediction. So it is better to close the position once the Tradespoon prediction changes, especially if you are getting close to expiration.
Always make sure to avoid Assignments, and close your position in order to do so. Also, always evaluate the Probability of the Stock reaching your targeted gain. Suppose if there is a Probability of reaching or surpassing the Target Gain prior to the Expiration Date, then it is better to close the position before expiration. It is always better to close the position once the stock moves 3-5% in your direction.
As we have seen Option Assignment always involves risk. If you do get assigned, make sure to close your position the very next day, unless of course you want to hold the stock for a long term. You could sustain big losses if you have Short Stock and it increases 100% or goes to infinity while you have unloaded risk. You can sustain unlimited losses if you have a long position and the stock drops to zero. So, always hedge your positions, and close them when applicable, in order to avoid unlimited and undue losses.