Options Mechanics

Two exercise styles for options contracts: American options can be exercised anytime from purchase until expiration, while European options can only be exercised at expiration. American-style options provide greater flexibility for early exercise when advantageous (such as deep in-the-money positions or dividend capture scenarios). The name refers to exercise timing, not where the option trades. Both styles can be bought or sold (closed) at any time before expiration.

Example: An investor owns an American-style call option on XYZ stock with a $50 strike price, currently tradi...

The process by which an option writer (seller) is required to fulfill their contractual obligation when the option holder exercises. The Options Clearing Corporation (OCC) randomly assigns exercise notices to clearing member firms, who then assign them to specific short option positions. Call writers must sell the underlying security at the strike price; put writers must buy the underlying security at the strike price. Assignment is automatic and cannot be refused once notified.

Example: Sarah sells (writes) 2 covered call options on XYZ stock with a $50 strike price and collects $300 i...

The act by which an option holder (buyer) invokes their right to buy (for calls) or sell (for puts) the underlying security at the strike price. Only the option holder can exercise; the seller cannot. Call exercise means buying at the strike price; put exercise means selling at the strike price. Exercise typically occurs when options are in-the-money, though holders can choose to exercise any time before expiration. Upon exercise, the option seller is assigned and must fulfill the obligation (deliver shares for calls, buy shares for puts). Exercise settlement is typically T+1.

Example: An investor owns a call option on XYZ stock with a $50 strike price. XYZ is currently trading at $58...

Terms describing the intrinsic value status of an option relative to the underlying asset's current market price. A call option is in-the-money (ITM) when the market price exceeds the strike price. A put option is ITM when the market price is below the strike price. Options are out-of-the-money (OTM) when they have no intrinsic value (opposite conditions), and at-the-money (ATM) when the market price equals the strike price. Only ITM options have intrinsic value and are typically exercised.

Example: An investor holds a call option with a $50 strike when the stock trades at $55. This call is $5 in-t...

The price paid by the option buyer to the option seller for the rights granted by the option contract. The premium consists of two components: intrinsic value (in-the-money amount) and time value (value from remaining time until expiration). The buyer pays the premium upfront and it is non-refundable, representing the maximum loss for the buyer regardless of how the underlying security moves.

Example: An investor buys a call option on ABC stock (trading at $52) with a $50 strike price for a $4 premiu...

The predetermined price at which an option holder can buy (call) or sell (put) the underlying security if they exercise the option. Set when the contract is created and remains fixed throughout the option's life. The relationship between strike price and current market price determines intrinsic value and whether the option is in-the-money, at-the-money, or out-of-the-money.

Example: An investor buys a call option on XYZ stock with a $50 strike price when the stock is trading at $48...