As an options trader, it is vital to realize the relationship between option holder who exercise options and option writer who receive the options assignment.
An option holder (or buyer) who choose to apply his right to buy or sell options at the strike price is said to has exercised the option.
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When the option holder decides to exercise his right under the option contract, the option writer (seller) of the same terms is assigned, require him to sell (in the case of call options) or buy (in the case of put options) the underlying stock at the contractual strike price.
The holder of an option may exercise the option at any time after buying it until the last trading day. The holder does not need to wait until the expiration date to exercise the option (American style). Do note that European style option can only be exercised on the expiration date and not before.
The exercise notices are irrevocable. Once generated, they cannot be recalled.
Call option holder exercise options = Buying the underlying stock at the strike price
Put option holder exercise options = Selling the underlying stock at the strike price
Call option writer receive options assignment = Selling the underlying stock at the strike price.
Put option writer receive options assignment = Buying the underlying stock at the strike price.
Whenever a call holder exercises the option contract, a call writer of the same terms is assigned the obligation to sell. Whenever a put holder exercises the option contract, a put writer of the same terms is assigned the obligation to buy.
When a customer placed an order through his broker to exercise his option, the Options Clearing Corporation (OCC) will ensure that the contract be honored.
Under the system, option buyer or seller need not depend upon the goodwill of one another for the transaction to go through. The OCC has the broad responsibility of ensuring the contracts are orderly settled by depending on the member brokerage firm to enforce assignment.
Buyers and sellers are not match together on a one-on-one basis. Therefore when the seller’s options are trading In The Money, exercise can occur anytime. It might not happen at all or it may happen on the last trading day.
When options are exercised long before the expiration date, that exercise options are assigned to any seller with open position in that option. The selection of seller to be assigned can be on a random basis or on a first in, first out basis.
Once an option is exercised, 100 shares of the stock must be delivered.
Delivery refer to the movement of 100 shares of the stock from the seller of the option to the buyer who exercise the option.
When a Call Option is exercised, this means that the buyer will make payment and received 100 shares of the stock and the seller received the payment and hand over ownership of the stock.
If the seller who received assignment of the options is not willing or unable to comply with the terms, OCC will facilitate the market and enforced the options assignment. The brokerage firm may seized the sellers assets, suspense his trading or take legal action as a mean to deal with the seller.
All these actions are done without the knowledge of the buyer who exercised the options. This is because the problem is between the violating seller, system of brokerage firm, exchange and the OCC. Therefore an orderly settlement of the contract ensure that everyone who is trading stock options is confidence to receive a smooth, dependable system where contacts are honored automatically and without fail.
Next go to Factors that Influence Options Valuation to understand how options prices are valued
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