Topics covered by this general overview of exercising options includes the differences between an American-style and a European-style exercise, selling stock after exercising a call option, and options expiring unexercised. View more information below.
Can I exercise my right to buy the stock at any time up to the expiration date?
As the holder of an equity or ETF call option, you can exercise your right to buy the stock throughout the life of the option up to your brokerage firm’s exercise cut-off time on the last trading day. Options exchanges have a cut-off time of 4:30 p.m. CT, for receiving an exercise notice. Be aware that most brokerage firms have an earlier cut-off time for submitting exercise instructions in order to meet exchange deadlines.
What is the difference between American-style exercise and European-style exercise?
All standardized equity options use American-style exercise. American-style exercise means that you can exercise your contract any day that the market is open before the expiration date. The last day to exercise a monthly American-style option is usually the third Friday of the month in which the contract expires (expiration Friday).
Most, but not all, index options use European-style exercise. This means that the only time you can exercise your contract is the last trading day (usually Friday) before expiration. Even though there is only one day to exercise your contract, you can always close out your option position in the market on any day prior to expiration.
Are all index options European-style exercise?
Most, but not all, index options are European-style.
Important to remember: Thursday before expiration is typically the last trading day for European-style index options. Each investor should ensure that they fully understand the product specifications of the product they intend to trade.
How soon can I sell the stock after I exercise a call option?
As soon as you tell your broker you want to exercise your right to buy the stock (strictly speaking, give irrevocable instructions) you are a stockowner. Because of the irrevocable nature of the call exercise, you are buying the stock at the strike price. You will want to become fully familiar with your brokerage firm’s practices. Some investors may be able to sell stock immediately upon exercise and others may not be able to sell until after the shares have settled.
Will my broker automatically exercise options that expire in-the-money?
Each brokerage firm has a procedure outlined in your account agreement forms. Customers should be familiar with these procedures. The option holder can always submit instructions to their broker regarding whether to exercise or not to exercise. A customer may decide not to exercise an in-the-money option in some cases. It is best to have an understanding with your broker on actual procedure. They may have a threshold imposed for automatically exercising customer orders. OCC uses the $.01 threshold for the positions of its clearing members as an administrative convenience, but your firm may have a different threshold. Here is a description of the procedure:
EXERCISE BY EXCEPTION
"Exercise by exception" is an administrative procedure used by OCC to expedite the exercise of expiring options by clearing members. In this procedure, OCC exercises options that are in-the-money by specified threshold amounts unless the clearing member submits instructions not to exercise these options. "Exercise by exception" is a procedural convenience extended to OCC clearing members, which relieves them of the operational burden of entering individual exercise instructions for every option contract. It is important to note "exercise by exception” is a procedure between OCC and its clearing members and is not intended to prevent the need for customers to communicate exercise instructions to their brokers:
"The exercise thresholds provided for in Rule 805(d) and elsewhere in the rules are part of the administrative procedures established by the Corporation to expedite its processing of exercises of expiring options by clearing members, and are not intended to dictate to clearing members which positions in customers’ accounts should or must be exercised." (Rule 805, Interpretation .02)
Expiring options subject to exercise by exception use the following thresholds to trigger exercise:
Equity options: $.01 per contract in-the-money in the customer account; $.01 per contract in-the-money in firm and market maker accounts. Index options: $.01 per contract in-the-money in all account types.
The difference between the exercise price and the “closing price” of the underlying security determine whether expiring options are in-the-money or not.
Individuals sometimes incorrectly refer to the "exercise by exception" procedure for expiring options as "automatic exercise." It is important to note "exercise by exception" always allows an OCC clearing member to make a choice not to exercise an option that is in-the-money by the exercise threshold amount or more, or to exercise an option that has not reached the exercise threshold amount. The exercise threshold amounts used in "exercise by exception" trigger "automatic" exercise only in the absence of contrary instructions from the clearing member. Because the right of choice is always involved in "exercise by exception," exercise under these procedures is not, strictly speaking, "automatic."
TO MINIMIZE THE POTENTIAL FOR ERROR CUSTOMERS SHOULD COMMUNICATE TO THEIR BROKER OR CLEARING MEMBER EXPLICIT INSTRUCTIONS TO EXERCISE, OR NOT EXERCISE, ANY EXPIRING OPTION CONTRACT.
Is there a comprehensive list on your website of options that derive their settlement value on Friday morning?
The exchanges that list the products will have that information available on their websites. You will need to check the specifications of each product you intend to trade.
When will I be assigned on a covered call (long stock + short call) where the short call option is now in-the-money?
There is no definitive way to determine when an option holder will exercise an option.
An investor might look at the premium of a call option to determine likelihood of early assignment. An option's premium consists of two parts: intrinsic value and time value. Intrinsic value is the amount by which an option is in-the-money. Time value is the premium amount in excess of the intrinsic value.
When an option holder exercises an option early, they forfeit any time value priced into the option. This is one reason that an option holder might not exercise an option early.
An option writer should consider the perspective of the option holder. The option holder most likely makes his or her decision to exercise or sell the option on the most profitable outcome.
The following example illustrates this point: Stock XYZ is currently trading at $32.80. A call option with a strike of $32.50 that expires in two weeks is currently trading at $1.10. The option is in-the-money by $0.30 ($32.80 minus $32.50). The time value for the option is $0.80 ($1.10 premium minus $0.30 in-the-money amount). If an investor exercises their call and immediately sells the stock, the profit is $0.30 (before commissions): the $32.80 stock selling price minus the $32.50 strike price. On the other hand, the investor can sell the option at $1.10. By exercising the option, the investor forfeits the option's time value of $0.80. In the above example, if the investor wanted to own the underlying stock, the choice to sell the option and use the option proceeds to buy the underlying stock might be the more profitable alternative.
Finally, OCC randomly assigns exercise notices to its clearing members who, in turn assign their customers. Ask your brokerage firm how it allocates assignments.
How many options expire unexercised? How many do option holders exercise?
According to OCC statistics for year 2014 (for activity in customer and firm accounts), the breakdown is as follows:
Closing Sells - 72.8%
Exercised - 6.7%
Long Expirations - 20.4%
I bought an index put option and now learned that it has a European-style exercise. Does this mean I cannot close my position until expiration?
The exercise style of an option does not prevent an investor from closing the position via a transaction on an exchange any time up to and including the last trading day.
An option holder can close a long (purchased) option contract by one of two methods: entering into a closing sale at an options exchange, or by exercising the contract. An option holder can only exercise a European-style exercise option at expiration, so the only way to close your position prior to expiration is to execute a closing trade.
Index options have different exercise styles and trading hours. Make certain you know the difference between closing an open option position by exercising the contract, and closing the position via a trade on an exchange. Even the last trading day for expiring options can vary. The contract specifications of these index products contain important trading information regarding these options. To review index contract specifications, visit the Product Specifications section of OCC's website.
Can I still exercise my rights to sell the security when the exchanges halt trading on a stock where I'm long puts.
Probably, but discuss this with your brokerage firm to be sure. If you are long stock (i.e., a protective put), you should be able to exercise and deliver your long stock and receive the strike price proceeds.
When a stock exchange halts trading in a stock, the options exchanges also halt trading in the options. This lack of trading typically does not affect the ability of put or call holders to exercise unless the put holder's brokerage firm imposes restrictions. Some firms may impose exercise restrictions for put holders who don't have long stock if the stock is hard to borrow or other reasons. There may be locating requirements in those instances.
Option holders are encouraged and may be required to enter explicit instructions with their firm to exercise any expiring option. Depending on when the trading halt occurred, the options may be removed from ex-by-ex- processing (automatic exercise). Read OCC Memo #30049 to learn more about trading halts.
Although OCC does not typically impose any exercise restrictions, the rules or regulations set by regulatory authorities and other self-regulatory organization may affect a brokerage firm’s acceptance of a customer's exercise instructions. OCC's rules and procedures do not override or take precedence over these regulations. Address any questions about such rules or their applicability to the exercise of a given option position to the brokerage firm holding the investor's position.
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