Options Exercise and Assignment Settlement
Options add a layer of complexity to settlement because exercise creates a new stock transaction that must settle separately from the original options trade.
Exercise Settlement
- When an option is exercised, the resulting stock transaction settles on a T+1 basis from the exercise date
- The option itself settles T+1 when originally traded
- Exercise creates a brand-new stock transaction with its own settlement timeline
- Cboe (Chicago Board Options Exchange) Rule 6.20 governs the exercise of options contracts
- Cboe Rule 6.21 covers the allocation of exercise notices
Assignment
- The assigned writer must deliver (for calls) or purchase (for puts) the underlying security
- Settlement follows standard settlement rules for the underlying security (T+1)
- Cboe Rule 6.22 governs delivery and payment upon exercise/assignment
- Assignment is random among all short option holders in that series through the Options Clearing Corporation's (OCC) assignment process
| Action | Call Option | Put Option |
|---|---|---|
| Exerciser (holder) | Buys the underlying stock at the strike price | Sells the underlying stock at the strike price |
| Assigned writer | Must deliver (sell) the underlying stock at the strike price | Must buy the underlying stock at the strike price |
| Settlement | T+1 from exercise date | T+1 from exercise date |
Exam Tip: Gotchas
- Assignment is random. Writers cannot choose whether they get assigned; OCC selects randomly among all short holders in that series.
- Call writers deliver stock; put writers buy stock. These roles are commonly reversed on exam questions.
Expiration and Exercise Timing
- Equity options expire on the third Friday of the expiration month (technically Saturday, with the last trading day being Friday)
- American-style options may be exercised at any time before expiration
- European-style options may be exercised only at expiration
- OCC automatic exercise: Options that are in the money by $0.01 or more at expiration are automatically exercised by OCC (unless the holder instructs otherwise)
Automatic Exercise Details
- This is called exercise by exception
- The $0.01 threshold applies to customer accounts
- Holders can submit a do not exercise instruction to prevent automatic exercise
- Holders can also exercise options that are NOT in the money by $0.01 (by submitting an exercise instruction)
Exam Tip: Gotchas
- OCC automatically exercises options that are in the money by just $0.01 at expiration. This low threshold is frequently tested.
- The resulting stock transaction from an exercise settles T+1 from the exercise date, not from the original option trade date.