Course · Act II: Expiration Day · Chapter 6

Option exercise and assignment

Exercise versus selling to close, how assignment is handed out, why an option one cent in the money at the close becomes 100 shares, and the dividend that triggers early assignment.

Exercise or sell

Exercise means using the right: a long call buys 100 shares at the strike, a long put sells them. Most holders never do. They sell to close, because selling collects the whole premium. Exercising collects only the intrinsic value and throws the extrinsic value away.

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With RocketCo at $102 on Thursday, the 100 call is quoted at $2.60. Exercise it and you buy $102 stock for $100: that is $2.00 of intrinsic value. Sell it and you get $2.60. The extra $0.60 is extrinsic value, and only a buyer of the contract pays you for it.

Assignment

Assignment is exercise seen from the short side. When a holder exercises, the OCC hands the notice at random to a broker with short contracts in that series, and the broker picks an account. One contract moves 100 shares, whoever ends up with it.

Short 100 call, collected $4.20

P/L per share at expiration×100 per contract

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The OCC, the Options Clearing Corporation, is the clearinghouse behind every listed US option. It stands between buyer and seller, so a short call has no single counterparty. Assigned, a short call must deliver 100 shares at the strike; with none in the account, it ends up short them. An assigned short put must buy 100 shares at the strike.

Assigned is not the same as losing. The chart is a short 100 call at $4.20 with the stock at $102: in the money, likely assigned, and still ahead until $104.20.

Exercise by exception

At expiration you do not have to press anything. The OCC exercises every equity option that finishes $0.01 or more in the money, unless the holder’s broker says not to. Everything else expires. A call one cent in the money at the close is a share purchase on Monday.

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The OCC calls it exercise by exception, not automatic exercise, because the holder can always say no, or can exercise an option that missed the threshold. Brokers can set their own thresholds and cutoff times. The shares, and the bill for them, arrive after the weekend.

American, European, dividends

American-style options can be exercised on any business day until expiration, so a short one can be assigned early. European-style options can only be exercised at expiration. US stock options are American. The early exercise to watch for is a call holder going after a dividend.

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Only shareholders get a dividend, and only if they own the shares before the ex-dividend date. A deep in-the-money call with less extrinsic value left than the dividend is worth exercising the day before. Its short side gets the assignment, and owes the dividend on any shares it ends up short.

Key terms

Exercise: Using the option’s right: a call buys 100 shares at the strike, a put sells them. It gives up any extrinsic value left.
Sell to close: Ending a long option by selling it. It collects intrinsic and extrinsic value, which is why most holders prefer it to exercise.
Exercise by exception: The OCC rule that exercises equity options $0.01 or more in the money at expiration, unless the holder says not to.
American-style option: Can be exercised on any business day until expiration, so its short side can be assigned early. US stock options are American.
Early assignment: Assignment before expiration. Most likely on a deep in-the-money call just before an ex-dividend date.

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