Options Trading – Exercise

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Dec 05 2006
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What is “automatic exercise” of an option?
The Options Clearing Corporation (OCC) has provisions for the automatic exercise of certain in-the-money options at expiration, a procedure also referred to as “exercise by exception.” Generally, OCC will automatically exercise any expiring equity call or put in a customer account that is $0.25 or more in-the-money, and an index option that is $.01 or more in-the-money. However, a specific brokerage firm’s threshold for such automatic exercise may or may not be the same as OCC’s. For example InteractiveBrokers policy differs from OptionsXpress pertaining to this matter.

What is the difference between American-style exercise and European-style exercise?
American-style exercise means you can exercise your contract any day that the market is open before the expiration date. The last day to exercise an American-style option is usually the third Friday of the month in which the contract expires (known as Expiration Friday). European-style exercise means that the only time you can exercise your contract is the last trading day (usually Friday) before expiration.
When and how is an option exercised?
An investor with a long equity call or put position may exercise that contract at any time before the contract expires, up to and including the Friday before its expiration. To do so, the investor must notify his brokerage firm of intent to exercise in a manner, and by the deadline specified by that particular firm.

Must you exercise an expiring in-the-money equity option?
An investor with an expiring long equity call or put position that is subject to automatic exercise does not have to exercise the contract. Instructions may be given through a brokerage firm to OCC not to exercise a call or put that is in-the-money by any amount. But logically you won’t do that because you need to fork out more money to buy the stock instead of just lock-in the profit by closing your in-the-money option position.

If I exercise an in-the-money call option, how soon can I sell the stock?
As soon as you tell your broker you would like to exercise your right to buy the stock (strictly speaking, given “irrevocable instructions”) you are deemed to be a stock owner. Because of the irrevocable nature of the call exercise, you will be buying the stock at the strike price, and you can sell those shares immediately after giving instructions to exercise.
What happens to my long option if I never sell or exercise it?
After its expiration date a call or put will cease to exist. If you own an option and it expires unexercised, you no longer have any of the rights inherent in that contract and you lose the premium you paid for it, plus any commissions and fees you incurred at its purchase. You are free to close out a long call or put before expiration by selling it if it has market value.

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