Basic Points

• “An option assignment represents the seller's obligation to fulfill the terms of the contract by either selling or buying the underlying security at the exercise price” (FINRA, 2020). 
• “This obligation is triggered when the buyer of an option contract exercises their right to buy or sell the underlying security” (FINRA). 
• In other words, assignment happens when you have a short option position and it gets exercised (called and converted to shares) by the counterparty. This usually takes place when a short option holder is ITM (in the money), but it could occur at any point while short an option, even if that option is just one leg in a bigger strategy. 
• Logically, there is a disincentive for exercising when a contract is ITM, but some traders might do it anyway if they perceive themselves to gain an advantage, such as disrupting an illiquid market. 

Intermediate: Risk Considerations

As FINRA (the Financial Industry Regulatory Authority) warns new traders, “To the average investor, there are likely a number of unfamiliar terms, but for an individual with a short options position—someone who has sold call or put options—there is perhaps no term more important than ‘assignment’–the fulfilling of the requirements of an options contract (2020).

 Source article: <https://www.finra.org/investors/insights/trading-options-understanding-assignment>

The reason why it is so important to understand is the critical dynamic of how assignment will suddenly affect delta balances (which means total directional exposure). 

All options have a delta rating showing their instantaneous directional stake. For example, if you are short a 60-delta put and you get assigned, then suddenly you will find yourself holding 100 shares long, which is a 40-delta jump in your bullish directional exposure. 

The threat of this sudden jump is the same mechanism for pin risk. If short an option that is about to expire, one tick (often one penny) is the entire difference between max profit and being assigned very expensive shares. One sometimes ruinous effect from this is from large moves in a stock after being assigned at least 100 shares of it. 

Advanced: Strategic Considerations

Assignment becomes more likely when short an ITM (in the money) option that is approaching expiration, but also approaching an ex-dividend date. The reason why a counterparty might want to exercise an option before ex-dividend, even one slightly-OTM, is so that they can receive the dividend. 

As a nuance of this, most non-REIT dividends are qualified, meaning that they are taxed at the more favorable long-term capital gains rate (REITs are funds based on real estate holdings and they may often have unqualified dividends if tax savings are passed down to the shareholders). Tax laws are different all over the world, and please consult a tax professional before making tax-related decisions. But regardless of your region, it is still worthwhile to understand this general idea because the dynamic of these tax benefits from qualified dividends do increase the probability of assignment when approaching ex-dividend dates.