The exercise process
June 7, 2010

The Exercise Assignment Process

When you own an option, you have the right to exercise.  Important:  You have the right - not the obligation.  As previously mentioned, you are going to be better served to sell your options when you no longer want to own them.  It is seldom a good idea to exercise.  Nevertheless, you should understand the process.

When an option owner notifies his/her broker to exercise an option, that person is choosing to do what the contract allows.  That means a call owner elects to buy 100 shares by paying the strike price per share.  The put owners elects to sell 100 shares and collect the strike price per share.

Once exercised, the option no longer exists.

When you exercise an option, someone is on the other end of the transaction.  It is not the person with whom you made the original trade.  All exchange traded options are fungible, and that means they are identical.  If you buy some IBM Oct 110 calls, they are identical with every IBM Oct 100 call.  Thus, when you exercise these call options, there is no way to find the person with whom you traded.

It's far more efficient for some options to be chosen at random.  That's the job of he Options Clearing Corporation.  When they receive (from your broker) your notice to exercise one or more options, they randomly choose a 'clearing member' and assign that exercise notice to them.  That clearing member then randomly assigned the exercise notice to one of its customers - your broker (for example).  That broker randomly assigns that exercise notice to one of its customers.

The only requirement is that the customer have a short position (i.e., he/she previously sold) that option and it has neither expired nor repurchased.

The person assigned that exercise notice must honor the contract.  If it was the sale of a call option, then stock must be sold at the strike price.

If it is a put option, stock must be bought at the strike price.

If you are assigned, it is noting to fear.  Many beginners get upset, believe something terrible has happened and move into a state of panic.  It's  not a big deal - unless it results in a margin call, and that is easy to avoid by being prepared..

These transactions take place overnight when the markets are closed.  If assigned an exercise notice, there is nothing for you to do.  When you look at your account the following morning, the transaction will already have taken place and it is irrevocable.

Mark D Wolfinger

Expiring Monthly: The Option Traders Journal

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