Assignment on a Physically Settled Stock Call: Buy Back or Deliver?
On 20 March, with Reliance Industries trading at ₹2,855, Ravi sells 8 lots of the 2,900-strike March call at ₹28. The lot size is 250, so he has written options on 2,000 shares, and expiry is 27 March. He holds no Reliance shares, has no securities-lending arrangement, and his account shows ₹6 lakh of margin; the broker has already collected the option premium. On 26 March, after an earnings announcement, the stock jumps to ₹2,975 and the 2,900 call trades at ₹82. The broker's risk system demands roughly ₹24 lakh as delivery margin by 4 p.m. and warns that stock options are physically settled. Ravi believes the spike will reverse after expiry and wants to hold the position or, failing that, borrow shares to deliver.
1. Quantify Ravi's position: premium collected, current intrinsic value, mark-to-market loss and the delivery obligation if the short call is exercised. Why has the margin demand jumped?
Read the worked answer
Premium collected = ₹28 × 2,000 = ₹56,000.
Intrinsic value at spot ₹2,975 = 2,975 − 2,900 = ₹75; at ₹82 the option carries ₹7 of time value. Mark-to-market loss = (82 − 28) × 2,000 = ₹1,08,000.
If the call is exercised he is assigned a short position in 2,000 shares and must deliver 2,000 Reliance shares on settlement - shares he does not own.
Margin jumps because the short is now deep in-the-money: delta is near 1 and the exchange/broker levies delivery margin ahead of expiry to cover the near-certainty of physical delivery, which is a cash obligation far larger than a normal option margin. His ₹6 lakh collateral is nowhere near the ₹24 lakh demanded or the ₹59.5 lakh cost of 2,000 shares at ₹2,975.
2. Compare three courses of action - buy back the call at ₹82, buy 2,000 shares at ₹2,975 and prepare to deliver, or do nothing and let the assignment process run. Use cash outflow and risk, not just P&L.
Read the worked answer
Buy back at ₹82: pays ₹1,64,000, nets the ₹56,000 premium already received, realising a loss of about ₹1,08,000. Position closes, delivery margin is released, no further exposure. Clean and fundable within his ₹6 lakh.
Buy 2,000 shares at ₹2,975: ₹59.5 lakh outflow, which he cannot fund without borrowing, and he then carries the stock's downside if it falls back. Delivery would extinguish the obligation and preserve the ₹56,000 premium, but the funding and price risk make this a directional stock trade, not a hedge.
Do nothing: the option is ₹75 in-the-money with one day to expiry, so exercise is close to certain. He would face auction purchase of 2,000 shares plus a short-delivery penalty, both at unknown prices, and the broker may square off or buy shares at his cost at any time. With no shares and no borrowing line, this is the worst risk-adjusted choice. Judgement: buying back is correct unless he genuinely wants to own Reliance and can arrange funding today.
3. What does the fact that stock options are American-style and physically settled imply for Ravi's plan to 'wait for the spike to reverse'?
Read the worked answer
American-style means the long holder may exercise any day before expiry, not only on the last day, so assignment can arrive overnight whenever the call is deep in the money. Physical settlement means exercise creates a real obligation to deliver shares, so Ravi's exposure is no longer just the option's mark-to-market - it is a potential auction purchase or penalty if he cannot deliver.
Waiting therefore exposes him to gap risk on the stock, to unpredictable auction prices, and to forced action by the broker. The only cushion is the ₹7 of time value, which may decay in his favour, but that is small compared with the delivery risk. A trader with no underlying shares should treat a deep in-the-money short stock call as a position to close, not to hold for a reversal.