Stock Borrow Costs and Early Exercise of American Options
Summary
The document examines whether hard-to-borrow shares make American call options more likely to be exercised early. One explanation is that high stock borrow costs can make exercising an in-the-money call attractive: the holder obtains shares that may then be lent out, creating value that could outweigh keeping the option. This is offered as a conceptual rationale for a possible relationship between borrow conditions and exercise incentives.
A competing answer argues that early exercise is usually driven by arbitrage economics, especially an in-the-money option trading below intrinsic value, or dividend-related incentives for puts when remaining time value is smaller than the dividend. Exercising while meaningful time value remains generally sacrifices that value and can add transaction costs. The discussion illustrates the disagreement with examples involving calls and dividends, but provides no empirical evidence or measured assignment probabilities. It also challenges claims about early assignment of out-of-the-money options, emphasizing that assignment incentives depend on the holder’s payoff and alternatives. The source is a debate, not a definitive model of exercise behavior.
Key ideas
- High borrow costs may increase the value of exercising a call early and lending the acquired shares.
- Early exercise can be motivated by arbitrage when an in-the-money option trades below intrinsic value.
- Dividend-related early exercise incentives may apply to puts when remaining time value is less than the dividend.
- Exercising an option with remaining time value can forfeit that value and incur transaction costs.
- The discussion offers competing explanations without empirical estimates of assignment likelihood.
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Full text
# Why does borrowability of shares inversely correlate with probability of assignment or exercise? # Why does borrowability of shares inversely correlate with probability of assignment or exercise? I transcribe 5:26 of this video. I don't know that YouTuber's credentials. > So looking back here, what could possibly cause you to get assigned early? If we look right here, AMD shares are listed as easy to borrow. That's really important to know, and it means that the risk of early assignment is almost non-existent. > If we put something like Tesla in, they're listed as hard to borrow and that slightly elevates your risk. If shares are harder to borrow, calls are more likely to get exercised, which puts you in a position where you could be hitting max loss early on account of early assignment like we just talked about. And there's some smaller OTC stocks things like this [the YouTuber is pointing to ticker symbol TSOI] that are less not available to borrow. These, pretty much the second that they're in the money, are going to be exercised so that's the risk that you earn right there. ## Answer by Daneel Olivaw (score 3) https://quant.stackexchange.com/a/58372 On a conceptual level, I guess he means that, referring to American call options, for hard-to-borrow stocks (thus with high borrow cost), the yield you can generate from lending the stock has higher value than the continuation value from sticking with the option, so it’s worth it to exercise now and immediately lend it out. ## Answer by Bob Baerker (score 2) https://quant.stackexchange.com/a/58404 I disagree with the author's premise. The primary reason that options are exercised early is because of discount arbitrage (an ITM option trades below its intrinsic value) or there is a dividend arbitrage in an ITM put (the time premium is less than the dividend, NOT the call). No one with a lick of sense would exercise an option that has time premium remaining because that would be throwing away the time premium and incurring more transactional costs (B/A spread and commissions if you're still paying them). In the above scenarios, early exercise occurs because of the P&L not because the stock is hard to borrow. I listened to another minute of the video and I think that the author really has no clue. He talks about the possibility of an OTM short options being assigned early because of a dividend. Now who wouldn't want that to happen to them? If the stock is \$102 and I'm short the \$105 call, please, make me sell it to you for \$105! It makes no sense at all. He continues his errors with another example. A stock is \$101 and you are short a \$100 call that's \$2. The company announces a \$2 dividend and the call owner exercises and you are assigned. Why in the world would he do that? He could sell the call for \$2 and buy the stock for \$101. Exercising throws a dollar of time premium away.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.