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.
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)
Test Your Knowledge
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