Discussing options expiration, exercise, and assignment
There's more to option trading than just picking the proper strike price. Once a position has been established, it's important for option players to know what courses of action are available so they can work to proliferate profits, or limit their losses, by the time the options expire. Below, we'll discuss options expiration, exercise, and assignment.
Options Expiration:
Equity options expire on Fridays, on either a monthly or weekly basis. Standard monthly options expire on the third Friday of every month, while weekly options -- you guessed it -- expire at the close each Friday. So, for example, an October 100 call would expire at the close on Friday, Oct. 21, while the weekly 10/7 100-strike call would expire at the close on Friday, Oct. 7.
If you choose not to take action on a trade by market close on the expiration date, your option will expire. For out-of-the-money options, many buyers will choose to simply let these options expire worthless, especially if it is not worth the brokerage fees to sell to-close the option. When this happens, the option buyer will lose the initial premium paid.
On the other hand, option sellers are typically looking for their contracts to expire out of the money. In these situations, the trader who sold the option to open can pocket the initial premium received on the sale.
Options Exercise:
When an in-the-money option expires, it will be automatically exercised upon expiration. But at any point within the option's lifetime, the buyer is able to exercise their in-the-money option to either buy (call options) or sell (put options) shares of an underlying equity at the strike price.
As an example, say a bullish trader purchased a 40-strike call option on XYZ. By the time expiration rolls around, XYZ is trading at $45 per share, and the trader decides that she would like to own the 100 underlying shares of XYZ, since she believes the stock will continue to rally. Before market close on expiration, the trader can choose to exercise her option and purchase 100 shares of XYZ for $40 per share, therefore receiving $4,500 worth of stock for $4,000.
Or, let's say the speculator was a short seller who bought 40-strike calls as an options hedge. By doing so, she just established a maximum repurchase price on the shorted shares that moved against her.
On the other hand, if a bearish trader had purchased a put option on XYZ for $50, she can then choose to sell the 100 underlying shares of XYZ to the put writer for $5,000, instead of the market value of $4,500. Or, perhaps the trader was an XYZ shareholder seeking options insurance in case of a dip. By exercising the in-the-money put, she minimized portfolio losses.
Options Assignment:
Assignment is what happens on the side of the option seller when the option buyer chooses to exercise their option. For call sellers, this can mean having the underlying shares called away; for put sellers, it means being obligated to purchase the underlying shares of XYZ at the strike-price. An option seller can be assigned at any point the option is in-the-money during the life of the option, although the risk of assignment increases as the option nears expiration.
Of course, there are other ways to exit an option trade before expiration, including the option to buy to close or sell to close an option, or you can adjust your position by rolling out, up, or down. As always, it's important to do your research and discuss your needs with your broker, and keep an eye on your positions.
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