Exercise and Assignment

You've learned the strategies; now let's look at the mechanics of how options actually get fulfilled. This is where the Options Clearing Corporation (OCC) comes in.

Exercise

• Exercise is when the option holder (buyer) uses their right to buy (call) or sell (put) at the strike price
• Only the holder can initiate exercise; sellers cannot choose to exercise
• Exercise is voluntary; the holder can choose to let the option expire if it's not profitable
• At expiration, in-the-money options are typically automatically exercised by the OCC

When Does Exercise Make Sense?

• Exercise a call when the market price is above the strike price (in-the-money)
• Exercise a put when the market price is below the strike price (in-the-money)
• Out-of-the-money options are not exercised; they expire worthless

Exam Tip: Gotchas

• Only the HOLDER can exercise. The writer cannot exercise; they can only be assigned.

Assignment

• Assignment is when the option writer (seller) is notified they must fulfill the contract
• Assignment occurs when a holder exercises their option
• The writer must then deliver shares (call) or buy shares (put) at the strike price
• Assignment is random among all writers of that option series
• The writer has no choice - once assigned, they must perform

How Assignment Works

1. Holder exercises the option
2. The OCC receives the exercise notice
3. The OCC randomly assigns the obligation to a clearing member (brokerage firm)
4. The firm assigns the obligation to one of its customers who is short that option
5. The assigned writer fulfills the contract

Exam Tip: Gotchas

• Assignment among writers is RANDOM, not based on who sold first or who has the largest position.

The Options Clearing Corporation (OCC)

The OCC is the central organization behind the listed options market. It plays several key roles:

• Acts as the guarantor and central counterparty for all listed options trades
• Becomes the buyer to every seller and the seller to every buyer (novation)
• Issues and clears all standardized options contracts
• Eliminates counterparty risk; the buyer doesn't need to worry about the seller's ability to perform
• Handles the assignment process when options are exercised
• Prepares the Options Disclosure Document (ODD)

Why the OCC Matters

Exam Tip: Gotchas

• The OCC is the guarantor of all listed options contracts. If a writer defaults on their obligation, the OCC steps in and fulfills the contract. This is why option buyers never need to evaluate the creditworthiness of option sellers.
• The OCC is NOT a regulator. It is a clearing organization and guarantor, not a regulatory body like the SEC.

Exercise vs. Assignment Summary