The term exercise by exception refers to the automatic exercise of in-the-money options at expiration. The Options Clearing Corporation (OCC) institutes exercise by exception unless explicit instructions prohibit exercising the option.
Also known as automatic exercise, exercise by exception is a process instituted by the OCC for the convenience of clearing members. If an option is positioned to expire in-the-money by $0.01 or more, the OCC will automatically exercise that option unless instructions from a broker or the holder of the option requests otherwise. The process protects the holder of the option from losing the intrinsic value of the contract.
The OCC uses the price of the underlying security at or before 4:01:30 p.m. Eastern Time on the day before expiration to determine if the option is in-the-money. This will be the last price occurring during normal trading hours for the security.