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Options Exercise, Assignment, and More: A Beginner's Guide

So your trading account has gotten options approval, and you recently made that first trade—say, a long call in XYZ with a strike price of $105. Then expiration day approaches and, at the time, XYZ is trading at $105.30.

Wait. The stock's above the strike. Is that in the money 1 (ITM) or out of the money 2  (OTM)? Do I need to do something? Do I have enough money in my account? Help!

Don't be that trader. The time to learn the mechanics of options expiration is before you make your first trade.

Here's a guide to help you navigate options exercise 3 and assignment 4 —along with a few other basics.

In the money or out of the money?

The buyer ("owner") of an option has the right, but not the obligation, to exercise the option on or before expiration. A call option 5 gives the owner the right to buy the underlying security; a put option 6  gives the owner the right to sell the underlying security.

Conversely, when you sell an option, you may be assigned—at any time regardless of the ITM amount—if the option owner chooses to exercise. The option seller has no control over assignment and no certainty as to when it could happen. Once the assignment notice is delivered, it's too late to close the position and the option seller must fulfill the terms of the options contract:

• A long call exercise results in buying the underlying stock at the strike price.
• A short call assignment results in selling the underlying stock at the strike price.
• A long put exercise results in selling the underlying stock at the strike price.
• A short put assignment results in buying the underlying stock at the strike price.

An option will likely be exercised if it's in the option owner's best interest to do so, meaning it's optimal to take or to close a position in the underlying security at the strike price rather than at the current market price. After the market close on expiration day, ITM options may be automatically exercised, whereas OTM options are not and typically expire worthless (often referred to as being "abandoned"). The table below spells it out.

• If the underlying stock price is...
• ...higher than the strike price
• ...lower than the strike price
• If the underlying stock price is... A long call is...
• ...higher than the strike price ...ITM and typically exercised
• ...lower than the strike price ...OTM and typically abandoned
• If the underlying stock price is... A short call is...
• ...higher than the strike price ...ITM and typically assigned
• If the underlying stock price is... A long put is...
• ...higher than the strike price ...OTM and typically abandoned
• ...lower than the strike price ...ITM and typically exercised
• If the underlying stock price is... A short put is...
• ...lower than the strike price ...ITM and typically assigned

The guidelines in the table assume a position is held all the way through expiration. Of course, you typically don't need to do that. And in many cases, the usual strategy is to close out a position ahead of the expiration date. We'll revisit the close-or-hold decision in the next section and look at ways to do that. But assuming you do carry the options position until the end, there are a few things you need to consider:

• Know your specs . Each standard equity options contract controls 100 shares of the underlying stock. That's pretty straightforward. Non-standard options may have different deliverables. Non-standard options can represent a different number of shares, shares of more than one company stock, or underlying shares and cash. Other products—such as index options or options on futures—have different contract specs.
• Stock and options positions will match and close . Suppose you're long 300 shares of XYZ and short one ITM call that's assigned. Because the call is deliverable into 100 shares, you'll be left with 200 shares of XYZ if the option is assigned, plus the cash from selling 100 shares at the strike price.
• It's automatic, for the most part . If an option is ITM by as little as $0.01 at expiration, it will automatically be exercised for the buyer and assigned to a seller. However, there's something called a do not exercise (DNE) request that a long option holder can submit if they want to abandon an option. In such a case, it's possible that a short ITM position might not be assigned. For more, see the note below on pin risk 7 ?
• You'd better have enough cash . If an option on XYZ is exercised or assigned and you are "uncovered" (you don't have an existing long or short position in the underlying security), a long or short position in the underlying stock will replace the options. A long call or short put will result in a long position in XYZ; a short call or long put will result in a short position in XYZ. For long stock positions, you need to have enough cash to cover the purchase or else you'll be issued a margin 8 call, which you must meet by adding funds to your account. But that timeline may be short, and the broker, at its discretion, has the right to liquidate positions in your account to meet a margin call 9 . If exercise or assignment involves taking a short stock position, you need a margin account and sufficient funds in the account to cover the margin requirement.
• Short equity positions are risky business . An uncovered short call or long put, if assigned or exercised, will result in a short stock position. If you're short a stock, you have potentially unlimited risk because there's theoretically no limit to the potential price increase of the underlying stock. There's also no guarantee the brokerage firm can continue to maintain that short position for an unlimited time period. So, if you're a newbie, it's generally inadvisable to carry an options position into expiration if there's a chance you might end up with a short stock position.

A note on pin risk : It's not common, but occasionally a stock settles right on a strike price at expiration. So, if you were short the 105-strike calls and XYZ settled at exactly $105, there would be no automatic assignment, but depending on the actions taken by the option holder, you may or may not be assigned—and you may not be able to trade out of any unwanted positions until the next business day.

But it goes beyond the exact price issue. What if an option is ITM as of the market close, but news comes out after the close (but before the exercise decision deadline) that sends the stock price up or down through the strike price? Remember: The owner of the option could submit a DNE request.

The uncertainty and potential exposure when a stock price and the strike price are the same at expiration is called pin risk. The best way to avoid it is to close the position before expiration.

The decision tree: How to approach expiration

As expiration approaches, you have three choices. Depending on the circumstances—and your objectives and risk tolerance—any of these might be the best decision for you.

1. Let the chips fall where they may.  Some positions may not require as much maintenance. An options position that's deeply OTM will likely go away on its own, but occasionally an option that's been left for dead springs back to life. If it's a long option, the unexpected turn of events might feel like a windfall; if it's a short option that could've been closed out for a penny or two, you might be kicking yourself for not doing so.

Conversely, you might have a covered call (a short call against long stock), and the strike price was your exit target. For example, if you bought XYZ at $100 and sold the 110-strike call against it, and XYZ rallies to $113, you might be content selling the stock at the $110 strike price to monetize the $10 profit (plus the premium you took in when you sold the call but minus any transaction fees). In that case, you can let assignment happen. But remember, assignment is likely in this scenario, but it is not guaranteed.

2. Close it out . If you've met your objectives for a trade, then it might be time to close it out. Otherwise, you might be exposed to risks that aren't commensurate with any added return potential (like the short option that could've been closed out for next to nothing, then suddenly came back into play). Keep in mind, there is no guarantee that there will be an active market for an options contract, so it is possible to end up stuck and unable to close an options position.

The close-it-out category also includes ITM options that could result in an unwanted long or short stock position or the calling away of a stock you didn't want to part with. And remember to watch the dividend calendar. If you're short a call option near the ex-dividend date of a stock, the position might be a candidate for early exercise. If so, you may want to consider getting out of the option position well in advance—perhaps a week or more.

3. Roll it to something else . Rolling, which is essentially two trades executed as a spread, is the third choice. One leg closes out the existing option; the other leg initiates a new position. For example, suppose you're short a covered call on XYZ at the July 105 strike, the stock is at $103, and the call's about to expire. You could attempt to roll it to the August 105 strike. Or, if your strategy is to sell a call that's $5 OTM, you might roll to the August 108 call. Keep in mind that rolling strategies include multiple contract fees, which may impact any potential return.

The bottom line on options expiration

You don't enter an intersection and then check to see if it's clear. You don't jump out of an airplane and then test the rip cord. So do yourself a favor. Get comfortable with the mechanics of options expiration before making your first trade.

1 Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the stock price is above the strike price. A put option is ITM if the stock price is below the strike price. For calls, it's any strike lower than the price of the underlying equity. For puts, it's any strike that's higher.

2 Describes an option with no intrinsic value. A call option is out of the money (OTM) if its strike price is above the price of the underlying stock. A put option is OTM if its strike price is below the price of the underlying stock.

3 An options contract gives the owner the right but not the obligation to buy (in the case of a call) or sell (in the case of a put) the underlying security at the strike price, on or before the option's expiration date. When the owner claims the right (i.e. takes a long or short position in the underlying security) that's known as exercising the option.

4 Assignment happens when someone who is short a call or put is forced to sell (in the case of the call) or buy (in the case of a put) the underlying stock. For every option trade there is a buyer and a seller; in other words, for anyone short an option, there is someone out there on the long side who could exercise.

5 A call option gives the owner the right, but not the obligation, to buy shares of stock or other underlying asset at the options contract's strike price within a specific time period. The seller of the call is obligated to deliver, or sell, the underlying stock at the strike price if the owner of the call exercises the option.

6 Gives the owner the right, but not the obligation, to sell shares of stock or other underlying assets at the options contract's strike price within a specific time period. The put seller is obligated to purchase the underlying security at the strike price if the owner of the put exercises the option.

7 When the stock settles right at the strike price at expiration.

8 Margin is borrowed money that's used to buy stocks or other securities. In margin trading, a brokerage firm lends an account owner a portion of the purchase price (typically 30% to 50% of the total price). The loan in the margin account is collateralized by the stock, and if the value of the stock drops below a certain level, the owner will be asked to deposit marginable securities and/or cash into the account or to sell/close out security positions in the account.

9 A margin call is issued when your account value drops below the maintenance requirements on a security or securities due to a drop in the market value of a security or when a customer exceeds their buying power. Margin calls may be met by depositing funds, selling stock, or depositing securities. Charles Schwab may forcibly liquidate all or part of your account without prior notice, regardless of your intent to satisfy a margin call, in the interests of both parties.  

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Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the Options Disclosure Document titled " Characteristics and Risks of Standardized Options " before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.

With long options, investors may lose 100% of funds invested. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received.

Short options can be assigned at any time up to expiration regardless of the in-the-money amount.

Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss.

Commissions, taxes, and transaction costs are not included in this discussion but can affect final outcomes and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Short selling is an advanced trading strategy involving potentially unlimited risks and must be done in a margin account. Margin trading increases your level of market risk. For more information, please refer to your account agreement and the Margin Risk Disclosure Statement.

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Exercise and Assignment

Options buyers  exercise  their options.

Options sellers are  assigned  when an option is exercised.

Exercising your right

A call option is the right to buy the underlying future at the strike price. The process for activating that “right”, is called “exercising the right” or simply to “exercise” the option. For a call option, that activity is also referred to as “calling the underlying” away from the option seller.

Options buyers (either put or call buyers) are the only ones that control whether an option can be exercised.  Option sellers have the obligation if assigned and thus have no control over the exercise procedure.

A put option gives the owner of the option, the right to “put” the underlying future, to the seller of the option. Imagine if a store offers a “30 day no questions asked return policy”, that is like a “put”. You can “put” the item back on the store’s shelf and get a refund. If you return the item to the store, you have “exercised your right” to sell the item back to the store.

Option buyers are the only options traders who can “exercise” the right. Call owners, those who are “long the call”, can exercise their right to buy the underlying at the strike price. And put owners, those who are “long the put”, can exercise their right to sell the underlying at the strike price.

Being assigned

Sellers of call options are  obligated  to sell you that future, at a specific price. They were paid a premium to take on the risk of having to sell you something at a lower price than the current market.

Similarly, the writers of put options are  obligated  to buy that future at the specific price, that is higher than the current market price.

When an option owner exercises the right embedded in the contract, someone has to be assigned the duty of fulfilling the obligation, and it may not be the original person who sold the option.

The process of assigning options is performed by the central clearing house. CME Clearing using an algorithm to randomize the assignment to the options sellers.

Options owners exercise their contracts when markets move in their favor. Sellers of options accept premium and could be assigned when markets benefit the buyers.

Long call option upon exercise results in long futures

Short call option upon assignment results in short futures position (futures called away)

Long put option upon exercise results in short futures position

Short put option upon assignment results in long futures position (long futures put into their account)

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Option Exercise & Assignment

American Style vs European Style

American style options can be exercised anytime before the expiration date . European style options on the other hand can only be exercised on the expiration date itself. Currently, all of the stock options traded in the marketplaces are American-Style options.

When an option is exercised by the option holder , the option writer will be assigned the obligation to deliver the terms of the options contract.

If a call option is assigned, the options writer will have to sell the obligated quantity of the underlying security at the strike price .

If a put option is assigned, the options writer will have to buy the obligated quantity of the underlying securty at the strike price.

Once an option is sold, there exist a possibility for the option writer to be assigned to fulfil his or her obligation to buy or sell shares of the underlying stock on any business day. One can never tell when an assignment will take place. To ensure a fair distribution of assignments, the Options Clearing Corporation uses a random procedure to assign exercise notices to the accounts maintained with OCC by each Clearing Member. In turn, the assigned firm must use an exchange approved way to allocate those notices to individual accounts which have the short positions on those options.

Options are usually exercised when they get closer to expiration . The reason is that it does not make much sense to exercise an option when there is still time value left. Its more profitable to sell the option instead.

Over the years, only about 17% of options have been exercised. However, it does not mean that only 17% of your short options will be exercised. Many of those options that were not exercised were probably out-of-the-money to begin with and had expired worthless. In any case, at any point in time, the deeper into-the-money the short options, the more likely they will be exercised.

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Option exercise and assignment explained w/ visuals.

• Categories: Options Trading

Last updated on February 11th, 2022 , 06:38 am

Buyers of options have the right to exercise their option at or before the option’s expiration. When an option is exercised, the option holder will buy (for exercised calls) or sell (for exercised puts) 100 shares of stock per contract at the option’s strike price.

Conversely, when an option is exercised, a trader who is short the option will be assigned 100 long (for short puts) or short (for short calls) shares per contract.

• Long American style options can exercise their contract at any time.
• Long calls transfer to +100 shares of stock
• Long puts transfer to -100 shares of stock
• Short calls are assigned -100 shares of stock.
• Short puts are assigned +100 shares of stock.
• Options are typically only exercised and thus assigned when extrinsic value is very low.
• Approximately only 7% of options are exercised.

The following sequences summarize exercise and assignment for calls and puts (assuming one option contract ):

Call Buyer Exercises Option   ➜  Purchases 100 shares at the call’s strike price.

Call Seller Assigned  ➜  Sells/shorts 100 shares at the call’s strike price.

Put Buyer Exercises Option  ➜  Sells/shorts 100 shares at the put’s strike price.

Put Seller Assigned   ➜  Purchases 100 shares at the put’s strike price.

Let’s look at some specific examples to drill down on this concept.

New to options trading? Learn the essential concepts of options trading with our FREE 98-page Options Trading for Beginners PDF.

Exercise and Assignment Examples

In the following table, we’ll examine how various options convert to stock positions for the option buyer and seller:

As you can see, exercise and assignment is pretty straightforward: when an option buyer exercises their option, they purchase (calls) or sell (puts) 100 shares of stock at the strike price . A trader who is short the assigned option is obligated to fulfill the opposite position as the option exerciser. 

Automatic Exercise at Expiration

Another important thing to know about exercise and assignment is that standard in-the-money equity options are automatically exercised at expiration. So, traders may end up with stock positions by letting their options expire in-the-money.

An in-the-money option is defined as any option with at least $0.01 of intrinsic value at expiration . For example, a standard equity call option with a strike price of 100 would be automatically exercised into 100 shares of stock if the stock price is at $100.01 or higher at expiration.

What if You Don't Have Enough Available Capital?

Even if you don’t have enough capital in your account, you can still be assigned or automatically exercised into a stock position. For example, if you only have $10,000 in your account but you let one 500 call expire in-the-money, you’ll be long 100 shares of a $500 stock, which is a $50,000 position. Clearly, the $10,000 in your account isn’t enough to buy $50,000 worth of stock, even on 4:1 margin.

If you find yourself in a situation like this, your brokerage firm will come knocking almost instantaneously. In fact, your brokerage firm will close the position for you if you don’t close the position quickly enough.

Why Options are Rarely Exercised

At this point, you understand the basics of exercise and assignment. Now, let’s dive a little deeper and discuss what an option buyer forfeits when they exercise their option.

When an option is exercised, the option is converted into long or short shares of stock. However, it’s important to note that the option buyer will lose the extrinsic value of the option when they exercise the option. Because of this, options with lots of extrinsic value remaining are unlikely to be exercised. Conversely, options consisting of all intrinsic value and very little extrinsic value are more likely to be exercised.

The following table demonstrates the losses from exercising an option with various amounts of extrinsic value:

As we can see here, exercising options with lots of extrinsic value is not favorable. 

Why? Consider the 95 call trading for $7. Exercising the call would result in an effective purchase price of $102 because shares are bought at $95, but $7 was paid for the right to buy shares at $95. 

With an effective purchase price of $102 and the stock trading for $100, exercising the option results in a loss of $2 per share, or $200 on 100 shares.

Even if the 95 call was previously purchased for less than $7, exercising an option with $2 of extrinsic value will always result in a P/L that’s $200 lower (per contract) than the current P/L. F

or example, if the trader initially purchased the 95 call for $2, their P/L with the option at $7 would be $500 per contract. However, if the trader decided to exercise the 95 call with $2 of extrinsic value, their P/L would drop to +$300 because they just gave up $200 by exercising.

7% Of Options Are Exercised

Because of the fact that traders give up money by exercising an option with extrinsic value, most options are not exercised. In fact, according to the Options Clearing Corporation,  only 7% of options were exercised in 2017 . Of course, this may not factor in all brokerage firms and customer accounts, but it still demonstrates a low exercise rate from a large sample size of trading accounts.

So, in almost all cases, it’s more beneficial to sell the long option and buy or sell shares instead of exercising. We like to call this approach a “synthetic exercise.”

Congrats! You’ve learned the basics of exercise and assignment. If you’d like to know how the exercise and assignment process actually works, continue to the next section!

Who Gets Assigned When an Option is Exercised?

With thousands of traders long and short options in the market, who actually gets assigned when one of the traders exercises their option?

In this section, we’ll run through the exercise and assignment process for options so you know how the assignment decision occurs.

If a trader is short a single option, how do they get assigned if one of a thousand other traders exercises that option?

The short answer is that the process is random. For example, if there are 5,000 traders who are long a call option and 5,000 traders who are short that call option, an account with the short option will be randomly assigned the exercise notice. The random process ensures that the option assignment system is fair

Visualizing Assignment and Exercise

The following visual describes the general process of exercise and assignment:

If you’d like, you can read the OCC’s detailed assignment procedure here  (warning: it’s intense!).

Now you know how the assignment procedure works. In the final section, we’ll discuss how to quickly gauge the likelihood of early assignment on short options.

Assessing Early Option Assignment Risk

The final piece of understanding exercise and assignment is gauging the risk of early assignment on a short option.

As mentioned early, only 7% of options were exercised in 2017 (according to the OCC). So, being assigned on short options is rare, but it does happen. While a specific probability of getting assigned early can’t be determined, there are scenarios in which assignment is more or less likely.

The following scenarios summarize  broad generalizations  of early assignment probabilities in various scenarios:

In regards to the dividend scenario, early assignment on in-the-money short calls with less extrinsic value than the dividend is more likely because the dividend payment covers the loss from the extrinsic value when exercising the option.

All in all, the risk of being assigned early on a short option is typically very low for the reasons discussed in this guide. However, it’s likely that you will be assigned on a short option at some point while trading options (unless you don’t sell options!), but at least now you’ll be prepared!

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Additional Resources

Exercise and Assignment – CME Group

Learn About Exercise and Assignment – CME Group

About the Author

Chris Butler received his Bachelor’s degree in Finance from DePaul University and has nine years of experience in the financial markets. 

Chris started the projectfinance YouTube channel in 2016, which has accumulated over 25 million views from investors globally.

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How Does Options Exercise & Assignment Work?

Exercise and assignment.

When a stock option is exercised, the call holder buys the stock, and the put holder sells stock. When options are exercised, the OCC decides to which brokerage firm, such as TastyWorks , the exercise will be assigned, and the brokerage in turn decides which customer will get the assignment.

When we are assigned an exercise and are required to sell our shares, the shares sold are said to have been called out or called away . Assignment occurs, then the shares are called out. Assignment on a short put means purchasing the stock.

Assignment is completely random, and an exercise can be assigned to and apportioned among several different call writers. Once assignment by OCC occurs, settlement between the buying and selling parties is automatic. Shares must be physically delivered once exercise occurs.

The covered call writer doesn’t have to do anything; the call writer’s broker handles settlement, delivers the shares and collects the exercise funds. Option exercise or assignment can be partial: one can exercise less than all the options held. Conversely, you may be assigned on less than all your short calls or puts.

However, one cannot exercise or be assigned on part of a single option contract . If you buy a call (put), you are not required to buy (sell) the underlying stock; you may sell the option to close or allow it to expire worthless.

Automatic Exercise

The OCC automatically exercises options that are $0.01 or more ITM, unless the option holder has notified his/her broker not to allow exercise of the option.

Note that a stock’s price can tick up or down after the close on expiration Friday, resulting in calls or puts (but not both calls and puts, obviously) that were near the money at Friday’s close becoming in the money – and being exercised.

If you are long calls on expiration Friday, you could find yourself purchasing shares unexpectedly, due to a late-day or after-market tick up in the stock.

Or if instead long the puts then, you might find yourself selling shares unexpectedly; and if you don’t own the underlying shares, this would either create a short stock position in your account, or your broker would buy you in (purchase the shares on your behalf) in order to cover itself.

Be sure your broker knows your wishes if you are long options at expiration and have not closed them. Writers of short calls and puts can similarly find themselves assigned an exercise due to the same mechanism.

Early Exercise

Because stock options are American-style, you can be assigned an exercise any time an option is in the money, although options typically are not exercised early while there is still time value remaining.

The reason is that the exercise of an option forfeits its time value; to capture the time value it is necessary to flip (sell) the option. But as expiration draws near, options that are in the money sometimes trade at parity, and this is when early exercise occurs.

Options trading below parity practically beg arbitrageurs to exercise them for risk-less profit. This subject is covered in more detail in the chapter on Portfolio Writing.

Where Stock Options Go:

60% – are traded out (sold or bought to close)

30% – expire worthless

10% – are exercised

Source: Chicago Board Options Exchange (CBOE)

Option traders like to say that only 10% of options are exercised, which is generally true, though not true in all cases. Thus if you write a call, the odds against assignment are roughly 9:1, statistically speaking.

But if a call is written ITM, the odds are quite high it will be exercised, despite the overall 9:1 odds. No matter where written originally, if the calls are in the money (ITM) $0.01 or more at expiration, exercise is a virtual certainty.

ATM and OTM options are never exercised, since it is cheaper to buy or sell the stock in the open market than to exercise an option.

Option Premiums

The premium is the price paid or received for an option. Options are traded much like stocks, with bid and asked prices shown:

• Seller generally receives the bid price
• Buyer generally pays the asked price
• The market maker or specialist keeps the spread between the bid and asked prices.

Example: A stock is trading at $30, and the July 30 Call prices are quoted as follows:

           Bid = 1.65   Asked = 1.70

This means the high bidder will pay $1.65, and the lowest price offered to buyers is $1.70. Note the 0.05 spread between the two prices.

Actually, the only time the seller can be assured of getting the bid price, or the buyer paying only the asked price, is to enter the trade order as a market order , in which case they get the market price at the time the order is executed.

Market makers have to execute a market order at market price, up to the number of contracts for which the bid or offer is good, but are not obligated to take limit orders. By using a limit order, the seller might get 1.70 or even 1.75 for writing the call. And the buyer can enter a limit order for less than 1.70 (ex: 1.65), in an attempt to buy the call more cheaply.

Historically, the premium referred to the total amount received for selling the contract, not to the option price. However, today the term “premium” simply means the option’s price on a per-share basis. That is, if the premium shown is bid at $0.80, that means $0.80 per share; you would expect to receive $80.00 ($0.80 x 100) for an entire option contract relating to 100 shares when using a market order. As we are about to see, premium is not just premium. The premium can be all intrinsic value, all time value, or contain both.

Option Premium: Intrinsic and Time Value

Intrinsic value is the portion of the premium that is in the money. Intrinsic increases dollar-for-dollar with the stock price as it moves. Only ITM calls have intrinsic value.

Intrinsic value = total premium – time value

Time Value is the portion of the premium that is not in the money. It is also known as “ extrinsic value ”. Time value is the amount upon which return is calculated in covered call writing. ATM and OTM premium is all time value. Time value = premium – intrinsic value.

Time value = total premium – intrinsic value

Calculating intrinsic and time value is simple. First, calculate the intrinsic value part of the premium. The remainder is time value. The entire premium of an ATM and OTM call will always be 100% time value. The following examples illustrate how to determine intrinsic and time value. In both examples assume the stock price is $20.

Example 1: ITM 17.50 Call – premium is $3.50:

Example 2: ATM 20 Call – premiums is $1.00:

Somehow, financial writers manage to make it sound as though the intrinsic value is the “real” or valuable part of the premium. Not so for the option seller!

The profit in covered call return calculations lies solely in the time value. Suppose for example that when the stock is $32.50 you were to write the 30 Call for a $3.00 premium, which seems fat.

But if assigned at the $30 strike price, you must sell the stock for $30. Thus your return will be the time value amount, which was only $0.50 (3.00 – 2.50 intrinsic value). Think of the intrinsic value as your money ; when selling the call, the intrinsic portion really is an advance payment of your money, since you could sell the stock and get the intrinsic amount immediately.

Note above in the intrinsic value definition that I said it increases dollar-for-dollar with the stock price. I am referring to the intrinsic value only. Suppose a stock is $30 and the current-month 30 Call can be sold for $1.25; obviously, the entire premium is time value since the call is not ITM.

If the stock moves up $1.00 to $31, the total premium may only increase $0.50 (to $1.75), not dollar-for-dollar with the stock. In this example, time value actually shrank from $1.25 to $0.75 with the stock’s rise. The 30 Call originally had $1.25 of time value, but the stock’s $1.00 price rise reduced the time value to $0.75 since the call is now $1.00 ITM.

Parity simply means that the option is trading precisely at intrinsic value and refers only to ITM options, since only they have intrinsic value. Options seldom trade more than a few pennies below parity (sub-parity). ITM options tend to trade at parity when:

• Expiration draws near and there is little time value left, or
• There is no expected volatility in the underlying stock.  

Characteristics of the Three Call Strikes

ATM calls (at-the-money calls), which are all time value, offer the most time value premium and the largest returns. They also provide a reasonable degree of downside protection should the stock price drop. ATM options usually are the most heavily traded because they are worth more to the market. Why? The trader is not paying for intrinsic value.

OTM calls (out-of-the-money calls), which also are all time value, offer less time value premium than ATM calls and provide the least downside protection. OTM time value premium usually is higher than for ITM calls, at least in flat or rising markets.

ITM calls (in-the-money calls) usually offer the least time value premium, especially in a rising market, but the biggest downside protection. On a falling stock, though, their time value premium can be comparable to or better than for OTM calls.

Throughout these articles, we will be referring to options as ITM, ATM or OTM. The easiest way to keep them straight is to learn them for call options. Then remember that ITM and OTM are the opposite for put options.

Time decay means that the time value portion of the option premium will shrink as time runs out. The intrinsic value portion of ITM calls never shrinks due to passage of time.

Time decay accelerates in the last 30 days of an option’s life, and the most rapid time decay occurs in the last 10 days. Time decay is one of the two reasons for writing calls in the current expiration month. (The other is premium compression , which means that the more time you sell, the less premium you receive per month sold.)

Stock does not expire and thus its price is not affected by the passage of time. The fact that options expire by their own terms means that they lose value at a steady rate (until the last 30 days, at any rate) – the time decay. Effects of time decay:

• Time – time is on the side of the call writer, not the call buyer, because time locks in the call writer’s profit . That is, when the call expires worthless, the call writer keeps all net premium received. On the other hand, time eventually destroys the option and thus the call buyer’s entire investment .
• The Ex-Monday Drop – time decay also explains why the premium for an option drops on the Monday following expiration, when the near-month option becomes the front month.

The following graph illustrates how an option loses value (decays) with the passage of time. Note the acceleration of time decay in the last 30 days and the very rapid acceleration in the last 10 days. Of course, it is the time value portion of option premium that decays; intrinsic value never decays.

    Figure 2.6

The time remaining in days to expiration is an important time factor. In legal terminology, an option is a wasting asset (it expires naturally with time), and as the option’s expiration date gets closer, the value of the option decreases.

The more time remaining until expiration, generally the more time value the option contract has. If the underlying asset price falls far below or far above the strike price of the option, the price of underlying asset in relation to the strike price becomes more significant in determining the option’s price.

On the day the option expires, the only value the option contract has is its intrinsic value, if any (ITM options).

Theta is the expected change in an option premium for a single day’s passage of time. That is, if all other factors are not changed, then option premium should be lower the next trading day by the theta value. Theta, then, expresses time decay of an option’s time value.

>> More: Introduction To Options

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• Trading Strategies
• Options Trading Basics

Options Exercise, Assignment, and More: A Beginner’s Guide to Options Expiration

Learn about options exercise and options assignment before taking a position, not afterward. This guide can help you navigate the dynamics of options expiration.

Key Takeaways

• Learn the basics of options exercise and options assignment
• Understand the difference between in-the-money and out-of-the-money options
• The surest way to avoid exercise or assignment is to liquidate or roll a position ahead of expiration, but remember, assignment of a short option can happen at any time 

So your trading account has gotten options approval and you recently made that first trade—say, a long call in XYZ with a strike price of $105. Then the option expires, and at the time, XYZ is trading at $105.30.

Wait. The stock’s above the strike. Is that in the money (ITM) or out of the money (OTM)? Do I need to do something? Do I have enough money in my account? Help!

Please, please, please: Don’t be that trader. The time to learn the mechanics of options expiration is before you make your first trade. Opening an account at TD Ameritrade entitles you to a host of free trading education, including an entire course on options trading. (And at the end of this article, you’ll find a short video covering the basics.)

Here’s a guide to help you navigate options exercise and assignment — along with a few other basics.

Memorize This Table (or Cut It Out and Paste It to Your Screen)

The buyer (“owner”) of an option has the right, but not the obligation, to exercise the option on or before expiration. A call option gives the owner the right to buy the underlying security; a put option gives the owner the right to sell the underlying security.

Conversely, when you sell an option, you may be assigned the underlying asset—at any time regardless of the ITM amount—if the option owner chooses to exercise. The option seller has no control over assignment and no certainty as to when it could happen.

An option will likely be exercised if it’s in the option owner’s best interest to do so, meaning if it’s advantageous from a price standpoint for the owner to take or to close a position in the underlying security at the strike price rather than at the prevailing price in the open market. After the close on expiration day, ITM options may be automatically exercised, whereas OTM options are not and typically expire worthless (often referred to as being “abandoned”). The table below spells it out.

This assumes a position is held all the way through expiration. Of course, you typically don’t need to do that. And in many cases, the usual strategy is to close out a position ahead of the expiration date. We’ll revisit the close-or-hold decision in the next section and look at ways to do that. But assuming you do carry the options position until the end, there are a few things you need to consider:

• Know your specs .Each standard equity options contract controls 100 shares of the underlying stock. That’s pretty straightforward. Non-standard options may have different deliverables. Non-standard options can represent a different number of shares , shares of stock of more than one company, or underlying shares and cash. Other products—such as equity index options or options on futures—have  different contract specs .
• Offsetting positions will match and close .Suppose you’re long 300 shares of XYZ and short one ITM call that’s assigned. That call is deliverable into 100 shares, so you’ll be left with 200 shares of XYZ if the option is assigned.

Exercise and Assignment: It’s Not Just at Expiration!

Standard U.S. equity options are American-style options, meaning they can be exercised anytime before expiration. If you’re short an option that’s deep ITM, it’s possible you’ll get assigned early. ITM short call positions are particularly vulnerable if a company is about to issue a dividend. ( Learn more about options and dividend risk .)

• It’s automatic, for the most part . If an option is ITM by as little as $0.01 at expiration, it will automatically be exercised for the buyer and assigned to a seller. However, there’s something called a Do Not Exercise request that a long option holder can submit if they want to abandon an option. In such a case, it’s possible that a short ITM position might not be assigned. For more, see the note below on pin risk, or refer to this advanced options expiration article . 
• You’d better have enough cash . If an XYZ option is exercised or assigned and you don’t have an offsetting position, you’ll essentially be exchanging an options position for a position in the underlying. A long call or a short put will result in a long position in XYZ; a short call or a long put will result in a short position in XYZ. For long stock positions, you need to have enough cash to cover the purchase or else you’ll be issued a margin call, which you must meet by adding funds to your account. But that timeline may be short, and the broker, at its discretion, has the right to liquidate positions in order to meet a margin call. If exercise or assignment involves taking a short stock position, you need a margin account and sufficient funds in the account to cover the margin requirement.
• Short equity positions are risky business . An uncovered short call or a long put, if assigned or exercised, will result in a short position. If you’re short a stock, you have potentially unlimited risk because there’s no limit to the price increase of a security. There’s also no guarantee the brokerage firm can continue to maintain that short position for an unlimited time period. So if you’re a newbie, it’s generally inadvisable to carry a position into expiration if there’s a chance you might end up with a short stock position.   

A note on pin risk : It’s rare, but occasionally a stock settles right on a strike price at expiration. So if you were short the 105 calls and XYZ settled at exactly $105, there would be no automatic assignment, but depending on the actions taken by the option holder, you may or may not be assigned—and you may not be able to trade out of any unwanted positions until the next business day.

But it goes beyond the exact price issue. What if an option is ITM as of the market close, but news comes out after the close (but before the exercise decision deadline) that sends the stock up or down through the strike price? Remember: The holder of the option could submit a Do Not Exercise request. 

This uncertainty and potential exposure is called pin risk, and the best way to avoid it is to close your position before expiration.

The Decision Tree: How to Approach Expiration

As expiration approaches, you have three choices. Depending on the circumstances—and your objectives and risk tolerance—any of these might be the best decision for you. 

Are options the right choice for you?

While options trading involves unique risks and is definitely not suitable for everyone, if you believe options trading fits with your risk tolerance and overall investing strategy, TD Ameritrade can help you pursue your options trading strategies with powerful trading platforms, idea generation resources, and the support you need.

Learn more about the potential benefits and risks of trading options.

Let the chips fall where they may . Some positions may not require as much maintenance. An options position that’s deeply OTM will likely go away on its own, but occasionally an option that’s been left for dead springs back to life. If it’s a long option, that might feel like a windfall; if it’s a short option that could’ve been closed out for a penny or two, you might be kicking yourself for not doing so.

Conversely, you might have a covered call against long stock, and the strike price was your exit target. For example, if you bought XYZ at $100 and sold the 110-strike call against it, and XYZ rallies to $113, you might be content with the $10 profit (plus the premium you took in when you sold the call, but minus any transaction costs). In that case, you can let assignment happen.

Close it out . If you’ve met your objectives for a trade—for better or worse—it might be time to close it out. Otherwise, you might be exposed to risks that aren’t commensurate with any added return potential (like the short option that could’ve been closed out for next to nothing, then suddenly came back into play).

The close-it-out category also includes ITM options that could result in an unwanted position or the calling away of a stock you didn’t want to part with. And remember to watch the dividend calendar. If you’re short a call option near the ex-dividend date of a stock, the position might be a candidate for early exercise. If so, you may want to consider getting out of the position well in advance—perhaps a week or more. Keep in mind, there is no guarantee that there will be an active market for an options contract, so it is possible to end up stuck and unable to close an options position.        

Roll it to something else . This is the third choice. Rolling is essentially two trades executed as a spread. One leg closes out the existing option; the other leg initiates a new position. For example, suppose you’re short a covered XYZ call at the July 105 strike, the stock is at $103, and the call’s about to expire. You could roll it to the August 105 strike. Or, if your strategy is to sell a call that’s $5 OTM, you might roll to the August 108 call. Keep in mind that rolling strategies can entail additional transaction costs, including multiple contract fees, which may impact any potential return. 

The Bottom Line on Options Expiration

You don’t enter an intersection and  then  check to see if it’s clear. You don’t jump out of an airplane and  then  test the rip cord. So do yourself a favor. Get comfortable with the mechanics of options expiration before you make your first trade. Your beating heart will thank you. 

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Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.

Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

Margin trading increases risk of loss and includes the possibility of a forced sale if account equity drops below required levels. Margin is not available in all account types. Margin trading privileges subject to TD Ameritrade review and approval. Carefully review the Margin Handbook and Margin Disclosure Document for more details. Please see our website or contact TD Ameritrade at 800-669-3900 for copies.

The risk of loss on an uncovered call options position is potentially unlimited since there is no limit to the price increase of the underlying security. The naked put strategy includes a high risk of purchasing the corresponding stock at the strike price when the market price of the stock will likely be lower. Naked options strategies involve the highest amount of risk and are only appropriate for traders with the highest risk tolerance. 

Spreads and other multiple-leg options strategies can entail additional transaction costs which may impact any potential return. These are advanced options strategies and often involve greater risk, and more complex risk, than basic options trades.

Please note that the examples above do not account for transaction costs or dividends. Options orders placed online at TD Ameritrade carry a $0.65 fee per contract. Orders placed by other means will have additional transaction costs.

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

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Options and Derivatives

Strategy & Education

Exercise: Definition and How It Works With Options

What Is Exercise?

Exercise means to put into effect the right to buy or sell the underlying financial instrument specified in an options contract . In options trading, the holder of an option has the right, but not the obligation, to buy or sell the option's underlying security at a specified price on or before a specified date in the future.

Key Takeaways

• In options trading, "to exercise" means to put into effect the right to buy or sell the underlying security that is specified in the options contract.
• To exercise an option, you simply advise your broker that you wish to exercise the option in your contract.
• If the holder of a put option exercises the contract, they will sell the underlying security at a stated price within a specific timeframe.
• If the holder of a call option exercises the contract, they will buy the underlying security at a stated price within a specific timeframe.
• Before exercising an option, it is important to consider what type of option you have and whether you can exercise it.

Understanding Exercise

If the owner of an option decides to buy or sell the underlying instrument—instead of allowing the contract to expire worthless or closing out the position —they will be "exercising the option," or making use of the right or privilege that is available in the contract.

An options holder may exercise their right to buy or sell the contract's underlying shares at a specified price—also called the strike price .

• Exercising a put option allows you to sell the underlying security at a stated price within a specific timeframe.
• Exercising a call option allows you to buy the underlying security at a stated price within a specific timeframe.

To exercise an option, you simply advise your broker that you wish to exercise the option in your contract. Your broker will initiate an exercise notice , which informs the seller or writer of the contract that you are exercising the option. The notice is forwarded to the option seller via the Options Clearing Corporation (OCC). The seller is obligated to fulfill the terms of an options contract if the holder exercises the contract.

The decision to exercise an option isn't always a clear-cut one. There are several factors that need to be considered and, more often than not, it's safer to hold or sell the option instead.

The majority of options contracts are not exercised but, instead, are allowed to expire worthless or are closed by opposing positions. For example, the holder of an option can close out a long call or put prior to expiration by selling it, assuming the contract has market value.

If an option expires unexercised, the holder no longer has any of the rights granted in the contract. In addition, the holder loses the premium they paid for the option, along with any commissions and fees related to its purchase.

Things to Consider When Exercising an Option

• What kind of option do you have? This is very important, as contracts have different guidelines. American-style contracts allow you to exercise them before their expiration date. European options may be exercised only after the contract has expired.
• Can you exercise your options? In some cases, such as with employee stock ownership plans (ESOPs), your shares may be vested , meaning that you will need to wait a set amount of time before you exercise the option.
• Will the cost outweigh the benefits? Exercising a contract costs you commission money, so make sure that the exercise price will make you money; otherwise, you'll end up paying more in fees and will lose out on any potential profit.
• Are there taxes involved? You will want to consider any tax implications associated with the type of contract you are exercising. An employee cashing out an ESOP, for example, will have to pay additional tax.

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