If you’ve ever wondered what happens “behind the scenes” when an option is exercised, this section walks through the logistics step by step. Test questions sometimes focus on the process, so it helps to see it in a concrete scenario:
An investor is long 1 ABC Jan $50 put. ABC’s market price declines to $45, and the investor exercises the put.
The $50 put is in the money by $5 ($50 strike − $45 market), so exercising can make sense. To exercise, the investor must submit exercise instructions to their broker-dealer (electronically, by phone, or in person).
When the firm receives the exercise notice, it notifies the Options Clearing Corporation (OCC). The OCC’s role is to assign the exercise fairly. The investor is long a $50 put, and there may be thousands of investors short that same $50 put contract. The OCC assigns the exercise notice to one of the member firms that has customers short the $50 put. That list can include the same firm that submitted the exercise notice if that firm has other customers who wrote the same contract.
Using a computer randomizer, the OCC assigns the contract to one of the firms with customers short the $50 put. This keeps the assignment fair by selecting a firm on a random basis. Remember, writers (investors with short options) generally want to avoid being assigned. From the writer’s perspective, the best-case outcome is often expiration.
A firm that is randomly chosen for assignment may have one or more customers short the $50 put. If it’s just one customer, the firm assigns that customer, requiring them to buy 100 ABC shares at $50. If the firm has multiple customers short the $50 put, it can choose which customer to assign using a FIFO (first in, first out) basis*, a random basis, or any other fair method. Using one of these methods, the firm assigns a specific customer, requiring them to fulfill the obligation to buy 100 shares at $50.
*A FIFO basis would select the customer that wrote the contract the earliest.
Once the writer is assigned, both parties have one business day to fulfill their side of the contract. The put holder (who has the right to sell) must deliver 100 ABC shares, and the put writer (who has the obligation to buy) must deliver $5,000 in cash ($50 × 100 shares). Both deliveries must be completed by T+1 (the first business day after the exercise).
Option exercise process
There are a few important cutoff times for exercising an option on the expiration date. First, 4:00 p.m. ET (3:00 p.m. CT) is the cutoff time to trade the contract. After the market closes, no more trades can occur. Holders then have 90 minutes after the close to submit exercise instructions. That means the broker-dealer must receive exercise notices by 5:30 p.m. ET (4:30 p.m. CT) on expiration Friday. If the option is not exercised, the contract officially expires at 11:59 p.m. ET (10:59 p.m. CT).
Another key concept is automatic exercise. If a contract is in the money by $0.01 or more on the expiration date, it is automatically exercised by the broker-dealer. This helps prevent an investor from accidentally letting a valuable option expire.
Even when a contract is in the money, an investor may not want exercise to occur. For example:
Long 1 BCD Feb 30 call
Market closes at $30.01 on expiration Friday
This call is in the money by $0.01. If the investor exercises, they can buy 100 shares for $30.00 and sell them for $30.01, creating a $1 profit ($0.01 × 100 shares). Depending on the investor’s concerns about stock risk, that $1 may not be worth exercising - especially because expiration is followed by a weekend, and the stock price could change before the market opens the next week.
To prevent automatic exercise, investors must submit contrary exercise advice (CEA). In plain terms, this is a notice to the firm not to exercise the option, even though it is in the money.
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