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
• The Options Clearing Corporation assigns randomly to a clearing firm; the firm then allocates to one of its short customers by a fair method (random selection or first-in, first-out)
• 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

• The Options Clearing Corporation assigns RANDOMLY to clearing firms, never by position size. The firm may then allocate to its own short customers either randomly or first-in, first-out.

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