What Is an Assignable Contract?
An assignable contract is a derivative contract that has a provision allowing the holder to give away the obligations and rights of the contract to another party or person before the contract's expiration date. The assignee would be entitled to take delivery of the underlying asset and receive all of the benefits of that contract before its expiry. However, the assignee must also fulfill any obligations or requirements of the contract.
Most often, assignable contracts are found in futures contracts. Also, most of the derivative contracts that trade on an exchange are not assignable. There are also assignable contracts in the real estate market that allow the transfer of property.
Assignable Contracts Explained
Assignable contracts provide a way for current contract holders to close out their position, locking in profits or cutting losses, before the expiration date of the contract. Holders may assign their contracts if the current market price for the underlying asset allows them to realize a profit.
As mentioned earlier, not all contracts have an assignment provision, which is contained in the contract's terms. Also, an assignment doesn't always take away the assignor's risk and liability, because the original contract could require a guarantee that—whether assigned or not—the performance of all terms of the contract must be completed as required.
- An assignable contract has a provision allowing the holder to give away the obligations and rights of the contract to another party or person before the contract's expiration date.
- The assignee would be entitled to take delivery of the underlying asset and receive all of the benefits of that contract before its expiry.
- An assignment agreement can allow a bank or a mortgage company to sell or assign an outstanding mortgage loan.
Assignment of a Futures Contract
Owners of assignable futures contracts may opt to assign their holdings instead of selling them in the open market via an exchange. A futures contract is an obligation stating a buyer must purchase an asset, or a seller must sell an asset at a preset price and a predetermined date in the future.
Futures are standardized contracts with fixed prices, amounts, and expiration dates. Investors can use futures to speculate on the price of an asset such as crude oil. At expiration, speculators will book an offsetting trade and realize a gain or loss from the difference in the two contract amounts.
If an investor holds a futures contract and the holder finds that the security has appreciated by 1% on or before the closing of the contract, then the contract holder may decide to assign the contract to a third party for the appreciated amount. The initial holder would be paid in cash, realizing the profit from the contract before its expiration date. However, a buyer of an assigned contract can take a loss by paying an above market price and risks overpaying for the asset.
Most futures contracts do not have an assignment provision. If you are interested in buying or selling a contract, make sure to carefully check its terms and conditions to see if it is assignable or not. Some contracts may prohibit assignment while other contracts may require the other party in the contract to consent to the assignment.
It's important to note that an assignment may be void if the terms of the contract change substantially or violate any laws or public policy.
Factors in the Futures Market
A futures contract might be assigned if there was an above market offer from the third party in an illiquid market where bid and ask spreads were wide. The bid-ask spread is the difference between the buy and sell prices. The spreads can be wide meaning there's an additional cost being added to the prices because there's not enough product to satisfy the order at a reasonable price. Liquidity exists when there are enough buyers and sellers in the market to transact business. If the market is illiquid, a holder might not be able to find a buyer for the contract, or there might be a delay in unwinding the position.
An investor looking to buy the futures contract might offer an amount higher than the current market price in an illiquid environment. As a result, the current contract holder can assign the contract and realize a profit, and both parties benefit. However, unwinding or selling the contract outright is the cleaner solution, and it also guarantees that all liabilities concerning the contract's obligations are discharged.
Unwinding Futures Contracts
However, holders of futures contracts don't need to assign the contract to another investor when they can unwind or close the position through a futures exchange. The exchange, or its clearing agent, would handle the clearing and payment functions. In other words, the futures contract can be closed before its expiration. The holder would incur any gains or loss depending on the difference between the purchase and sale prices.
An investor who assigns a futures contract can realize a profit from the contract before its expiry.
An investor might receive an above market price for assigning a contract in an illiquid market.
Most futures contracts are not assignable.
A buyer of an assigned contract can take a loss by paying an above market price for the asset.
Real Estate Assignment
An assignment agreement can allow a bank or a mortgage company to sell or assign an outstanding mortgage loan. The bank may sell the mortgage loan to a third party. The borrower would receive notice from the new bank or mortgage company servicing the debt with information on payment submission.
The terms of the loan, such as interest rate and duration, will remain the same for the borrower. However, the new bank would receive all of the interest and principal payments. Aside from the name on the check, there should be little difference noticed by the borrower.
Banks will assign loans to remove them as a liability on their balance sheets and allow them to underwrite new or additional loans.
Real World Example of an Assignable Contract
Let's say an investor entered into a futures contract that contains an assignable clause in June to speculate on the price of crude oil, hoping the price will rise by year-end. The investor buys a December crude oil futures contract at $40, and since oil is traded in increments of 1,000 barrels, the investor's position is worth $40,000.
By August, the price of crude oil has risen to $60, and the investor decides to assign the contract to another buyer because the buyer was willing to pay $65 or $5 above market. The contract is assigned to the second buyer for $65, and the original buyer earns a profit of $25,000 (($65-$40) x 1000).
The new holder assumes all responsibilities of the contract and can profit if crude oil is trading above $65 by year-end, but also can lose if the oil trades below $65 by year-end.