Exercise (Options)

Definition

The term exercise refers to the right granted in an options contract which allows the holder to buy or sell the underlying asset. American options allow the holder to exercise this right any time before the contract expires.

Explanation

The right to exercise an option always rests with the holder or the investor taking the long position in the contract. While the holder of a call option has the right to buy the underlying commodity, the holder of a put can exercise their right to sell the underlying commodity. Investors that take a short position in an option are assigned when a holder exercises an option.

When a buyer exercises their option, a notice is sent to the seller of the contract as determined by the Options Clearing Corporation (OCC). When this occurs, the seller is said to be assigned; the process of assignment is random. American options provide the holder with the right, but not an obligation, to exercise their option at any time before its expiration. However, the writer of an option has an obligation to sell or buy the underlying security if assigned. In practice, most options are never exercised by the holder and expire worthless or are eventually closed out.

Related Terms

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