If you’ve ever wondered what happens “behind the scenes” when an option is exercised, this section walks you through the logistics. Test questions sometimes focus on these mechanics, so it helps to see the full sequence in a concrete example.
An investor is long 1 ABC Jan $50 put. ABC’s market price declines to $45, and the investor exercises the put.
Because ABC is trading at $45, the $50 put is in the money by $5. Exercising makes sense because the put gives the holder the right to sell shares at $50 when the market is lower.
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 ensure the exercise is assigned fairly. For every investor long the $50 put, there may be thousands of investors short that same $50 put. 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 it also 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 process fair by selecting a firm on a random basis. Option writers (investors with short options) generally want to avoid assignment; their best-case outcome is that the option expires.
A firm that is selected for assignment may have one or more customers short the $50 put:
Using one of these methods, the firm assigns a specific customer, forcing them to fulfill their obligation to buy 100 ABC 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:
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.
That means the broker-dealer must receive exercise notices by 5:30 p.m. ET on expiration Friday. If the option is not exercised, it officially expires at 11:59 p.m. ET.
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 at $30.00 and sell them at $30.01, for a total profit of $1 ($0.01 × 100 shares). Depending on the investor’s risk concerns, a $1 profit may not be worth the exposure - 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, the investor must submit contrary exercise advice (CEA). In plain terms, this is a notice to the firm not to exercise the option, even though it has intrinsic value (is in the money).
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