Fundamentals of Equity Options

Buyer vs. Seller

Download: Fundamentals of Equity Options

Either of these two basic terms may be commonly used by option investors to mean different things.
Don’t let this be a source of confusion. Read on and you will learn about:

The terms “buyer” and “buy” having different meanings depending on the context
The terms “seller” and “sell” having different meanings depending on the context

Buy / Buyer

Literally speaking, anyone who purchases an option contract can be called a “buyer.” This is
accomplished by entering a “buy” order with a brokerage firm, and having that order executed at the
CBOE or any other option exchange. But since there are “opening purchase” and “closing purchase”
transactions, what an option buyer is actually accomplishing may be one of two things.

Buy to Open

First, the buyer may be opening a long position in an option contract, or purchasing a right to buy (for a
call), or sell (for a put) shares of underlying stock. The result is that the buyer owns, or is long an
option in his brokerage account.

Buy to Close

Second, the buyer may be closing an existing short position in a call or a put. In other words the buyer
is voiding any obligations assumed via the terms of that short contract, that is to sell (for a short call) or
buy (for a short put) shares of underlying stock if assignment is received. In this scenario the buyer will
not own an option. Instead, he will no longer have a short position in the contract he bought.

Whichever the case, the implication of the words “buy” and/or “buyer” should be clear from the context
in which you may read or hear either of these words used.

Examples:

“Investor A is bullish on XYZ stock so he buys an XYZ call option.”

This investor is opening a long call position with an opening purchase transaction. In other words he is
“buying to open,” and expects to profit from an increase in the price of XYZ stock.

“Investor B is short an XYZ put, but no longer wants the risk of being assigned so he buys that put in
the marketplace.”

This investor is closing a short put position with a closing purchase transaction, or “buying to close,”
and is voiding his potential obligation to buy underlying XYZ shares. After the purchase he has no
position in the XYZ put, and is therefore no longer subject to assignment (as long as the put is
purchased before he is assigned).

Sell / Seller

Again literally speaking, anyone who sells an option contract can be called a “seller.” This is
accomplished by entering a “sell” order with a brokerage firm, and having that order executed. But
since there are “opening sale” and “closing sale” transactions, what an option seller is actually
accomplishing may also be one of two things.

Sell to Open

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 First, the seller may be opening a short position. In other words he is selling an option contract he
doesn’t currently own, or “writing” that contract. By doing so he is assuming the obligations of a short
option position to sell (for a short call) or buy (for a short put) shares of underlying stock if assignment
is received. The result is that the seller now maintains a short option position in his brokerage account.

Sell to Close

Second, the buyer may be closing an existing long position in a call or a put. By doing so the seller is
voiding any rights conveyed by the long contract to buy (for a call), or sell (for a put) shares of
underlying stock. The result is that the buyer no longer has a long position in that option, so he can no
longer exercise it.

Again, whichever the case the implication of the words “sell” and/or “seller” should be clear from the
context in which you may read or hear either of these words used.

Examples:

“The price of XYZ stock has increased as expected, so Investor A sells his XYZ call option at a profit.”

This investor is closing a long call position, via a closing sale transaction. He is “selling to close” in
other words. He has decided to realize his call profit, and invest those profits elsewhere.

“Investor B is moderately bullish on XYZ stock so he sells an XYZ put option.”

This investor is opening a short put position with an opening sale transaction. In other words he is
“selling to open,” and expects his profit to be the premium received from this sale, which he keeps
whether assigned or not.

“Investor C decides to establish a covered XYZ call position so he buys 100 shares of XYZ stock and
sells 1 XYZ call.”

In addition to buying shares of XYZ stock, this investor is also opening a short call position with an
opening sale transaction. He is “selling to open,” will maintain this short call in his brokerage account,
and can be assigned on the short contract at any time before it expires. The fact that the short call is
“covered” by the purchased XYZ shares does not prevent assignment.

Buy/Buyer vs. Sell/Seller – Generic Usage

As a matter of routine, you will both see and hear the words buy (or buyer) and sell (or seller) used in a
very general or generic sense. This might be in industry literature, in a seminar given by a
professional, or in conversation with other investors like you.

The word “buy” is also commonly used in a more general sense, or to imply taking a long position in a
call or put option. In the same tone, “buyer” is used to refer to investors who purchase and hold such
long positions in their brokerage accounts.

“Sell,” on the other hand can also be used in a general way to imply taking a short position in a call or
put, and “seller” referring to those investors taking short positions. These sellers are writing option
contracts.

Just as in earlier examples, the context in which these words are used should clarify the sense in
which they are meant to be taken.

Examples:

“When you buy an option your risk is known in advance and limited to the price paid for the contract;

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 when you sell an option your risk is unknown and can be substantial.”

In this context, the word “buy” implies in a general way taking a long option position in a call or put. On
the other hand, the word “sell” implies taking a short position in a call or put. You know this because of
the way the risks for each are characterized. In other words, long options carry limited risk while short
options carry substantial (or unlimited) risk. The speaker (or author) of these words is associating “buy”
with “long,” and “sell” with “short.”

The same goes for “buyer” vs. “seller.”

“Option buyers are purchasing a right to buy or sell underlying shares; option sellers are assuming an
obligation to buy or sell stock if they are assigned.”

Again, the word “buyer” implies in a general way taking a long position in a call or put. “Seller” implies
taking a short position. You know this because of the way the contract terms are described.
Purchasing a right to buy or sell underlying stock defines a long call or put. Assuming an obligation to
buy (or sell) stock defines the terms of a short put (or call).

To Summarize

As you can see, the context in which the words “buy or buyer” vs. “sell or seller” should help clarify any
confusion about the sense in which they are being used. If you see or hear these words used in a
context in which you don’t clearly understand their implication, such as when you’re getting investment
advice, then by all means check with your broker before moving into the marketplace to make a trade.

Open vs. Close

Each of your option orders, whether you are buying or selling an option contract, may be described by
one of these two basic terms. In fact, each time you place an option order with your brokerage firm you
might be required to specify whether it is an opening or a closing transaction. In this tutorial you will
learn about:

The concept (and result) of an “opening” transaction

The concept (and result) of a “closing” transaction
The effect of exercise & assignment on your option position
The concepts of “multiple listing” and “fungibility”

Opening Transactions

An opening transaction is one that either creates a new option position, or increases an existing one. It
can result from either a buy order or a sell order. Let’s consider both cases.

Opening Purchase

A transaction in which you either create or increase a long position in a specific call or put
option contract (or option series).

Creating a Long Position

0 = no existing position in XYZ June 60 calls

+ 1 = purchase of 1 XYZ June 60 call
+ 1 = new position of long 1 XYZ June 60 call

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 Prior to entering your buy order, you had no position in XYZ June 60 calls. You
then purchase 1 contract. This is an opening purchase transaction because you
have created a new position of long 1 XYZ June 60 call.

Increasing a Long Position

+ 2 = existing position of long 2 XYZ June 60 calls

+ 1 = purchase of 1 additional XYZ June 60 call
+ 3 = total position of long 3 XYZ June 60 calls

Prior to entering your current buy order, you were already long 2 XYZ June 60 calls
from a previous purchase. You then purchase 1 XYZ June 60 call. This is an
opening purchase transaction because you were long 2 calls and have now
increased your position to long 3.

Opening Sale

A transaction in which you either create or increase a short position in a specific call or put
option contract (or option series).

Creating a Short Position

0 = no existing position in XYZ June 60 calls

- 1 = sale of 1 XYZ June 60 call
- 1 = new position of short 1 XYZ June 60 call

Prior to entering your current sell order, you had no position in XYZ June 60 calls.
You then sell (or write) 1 contract. This is an opening sale transaction because you
have created a new position of short 1 XYZ June 60 call.

Increasing a Short Position

- 3 = existing position of short 3 XYZ June 60 calls

- 1 = sale of 1 XYZ June 60 call
- 4 = total position of short 4 XYZ June 60 calls

Prior to entering your current sell order, you were already short 3 XYZ June 60
calls from a previous sale. You then sell 1 XYZ June 60 call. This is an opening
sale transaction because you were short 3 calls and have now increased your
position to short 4.

Open vs. Close - Continued

Closing Transactions

A closing transaction is one that either eliminates or reduces an existing option position. It can result
from either a buy order or a sell order. Let’s consider both cases.

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 Closing Purchase

A transaction in which you either eliminate or reduce a short position in a specific call or put
contract (or option series). This action is commonly referred to as “covering” an existing short
call or short put contract.

Eliminating a Short Position

- 2 = existing position of short 2 XYZ June 60 calls

+ 2 = purchase of 2 XYZ June 60 calls
0 = no position in XYZ June 60 calls

Prior to entering your sell order, you were short 2 XYZ June 60 calls. You then buy
2 contracts. This is a closing purchase transaction because you have eliminated
your existing position and are now short no XYZ June 60 calls.

Reducing a Short Position

- 4 = existing position of short 4 XYZ June 60 calls

+ 2 = purchase of 2 XYZ June 60 calls
- 2 = total position of short 2 XYZ June 60 calls

Prior to entering your current buy order, you were already short 4 XYZ June 60
calls from a previous sale. You then purchase 2 XYZ June 60 calls. This is a
closing purchase transaction because you were short 4 calls and have now
decreased your position to short only 2.

Closing Sale

A transaction in which you either eliminate or reduce a long position in a specific call or put
option contract (or option series)

Eliminating a Long Position

+ 5 = prior long position in XYZ June 60 calls

- 5 = current sale of 5 XYZ June 60 calls
0 = no position in XYZ June 60 calls

Prior to entering your sell order, you were long 5 XYZ June 60 calls. You then sell 5
contracts. This is a closing sale transaction because you have eliminated your
existing position and are now long no XYZ June 60 calls.

Reducing a Long Position

+ 6 = prior position of long 6 XYZ June 60 calls

- 3 = current sale of 3 XYZ June 60 calls
+ 3 = total long position in XYZ June 60 calls

Prior to entering your current sell order, you were already long 6 XYZ June 60 calls
from a previous purchase. You then sell 3 XYZ June 60 calls. This is a closing sale
transaction because you were long 6 calls and have now decreased your position

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 to long only 3.

Open vs. Close - Continued

Offsetting Transactions

Closing purchases and sales are commonly referred to as “offsetting” transactions.

Closing Purchase

If you are short an option contract, you have taken on an obligation to buy (in the case of a put) or sell
(in the case of a call) underlying stock if you are assigned. In order to terminate this obligation, you
offset (or cancel) it by purchasing a contract in the marketplace that has the same terms (underlying
stock, expiration month and strike price). This must be done before you are assigned.

Closing Sale

If you are long an option contract, you’ve bought the right to buy (in the case of a call) or sell (in the
case of a put) underlying stock if you choose to exercise it. If you sell that option, whether at a profit or
a loss, you have offset (or cancelled) your right. In other words, you no longer own a long option to
exercise.

Multiple Listing & Fungibility

Options of a given class, for example all options on XYZ stock, may be listed and traded on any or all
of the options exchanges in the United States. In other words, they may be multiply listed. Option
series that are multiply listed, such as all XYZ June 60 calls, will have the same contract terms:
underlying stock, unit of trade, strike price and expiration month.

The result is that multiply listed options are “fungible” contracts. This unusual word simply means that
an option bought on one exchange may be sold on another exchange that lists and trades the exact
same contract. In other words, an option position can be opened on one exchange and then closed on
another.

If you have any question about this, before you make a closing transaction on an exchange other than
the exchange on which you opened your position, consult with your broker first. A mistake in this
matter could result in your opening a new position instead of closing an existing one.

Exercise & Assignment

After you exercise a long option, you will either buy (for a call) or sell (for a put) shares of underlying
stock. When you are assigned on a short contract you are obligated to do the reverse: sell (for a call)
or buy (for a put) underlying stock. The effect on your overall option position is that after exercise of, or
assignment on an option, that contract ceases to exist. That is to say, the option position is closed, and
a stock transaction takes place.

Exercising a Long Position

+ 6 = existing position of long 6 XYZ June 60 calls

- 2 = exercise 2 XYZ June 60 calls
+ 4 = total position of 4 long XYZ June 60 calls

You are long 6 XYZ June 60 calls, and you exercise 2 of these contracts. This

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 exercise has the effect of a closing sale transaction because you were long 6 calls
and have now decreased your position to long only 4. The 2 calls you exercised
have been replaced with a purchase of 200 shares of XYZ stock (100 shares per
contract) at $60 (strike price) per share.

Assignment on a Short Position

- 4 = existing position of short 4 XYZ June 60 calls

+ 3 = assignment on 3 XYZ June 60 calls
- 1 = total position of short 1 XYZ June 60 call

You are short 4 XYZ June 60 calls, and you are assigned on 3 of these contracts.
This assignment has the effect of a closing purchase transaction because you
were short 4 calls and your position has now decreased to short only 1. The 3 calls
you were assigned on have been replaced with a sale of 300 shares of XYZ stock
(100 shares per contract) at $60 (strike price) per share.

Put This All Together

Now you understand the meaning and consequences of opening and closing option transactions.
Again, you might be required to identify your option orders with one of these terms when you enter
them with your brokerage firm:

Opening Purchase
Opening Sale
Closing Purchase
Closing Sale

As a review, take an investor who begins with no position in XYZ June 60 calls. As he buys and sells
call contracts, and either exercises or is assigned, see how each transaction is identified, as well as
how it changes his overall position.

Read each row of the table below from left to right, top to bottom:

Current Type of Resulting

Action
P osition Transaction Position
0 Buy 10 Opening Purchase Long 10
Long 10 Sell 2 Closing Sale Long 8
Long 8 Sell 15 Closing Sale (8 long contracts) Short 7
Opening Sale (7 short contracts)
Short 7 1 Assigned Assignment Short 6
Short 6 Sell 3 Opening Sale Short 9
Short 9 Buy 2 Closing Purchase Short 7
Short 7 Buy 10 Closing Purchase (7 contracts) Long 3
Opening Purchase (3 contracts)
Long 3 1 Exercised Exercise Long 2
Long 2 Sell 2 Closing Sale 0

Long vs. Short

These two basic terms are commonly used by not only option investors, but also by investors in other

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 kinds of financial instruments. Here, we will focus on their use by equity option investors. Read on and
you will learn about:

The concept of being “long” option contracts

The concept of being “short” option contracts
The concepts of being “long” or “short” in terms of market expectations

What Can “Long” Mean?

“Long” Options

When you buy (purchase) an equity option contract, either a call or put, and hold that position in your
brokerage account, you are then “long” that contract. You have purchased the right to buy (in the case
of a long call) or sell (in the case of a long put) shares of underlying stock if you choose to exercise the
option.

Calls:

If you buy 1 XYZ call, then you are long 1 XYZ call contract.
If you buy 10 XYZ calls, then you are long 10 XYZ call contracts.

In either case, you have the right to buy 100 underlying XYZ shares per call option contract if you
choose to exercise this right.

Puts:

If you buy 1 XYZ put, then you are long 1 XYZ put contract.
If you buy 10 XYZ puts, then you are long 10 XYZ put contracts.

In either case, you have the right to sell 100 underlying XYZ shares per put option contract if you
exercise.

Calls and Puts:

If you purchase 1 XYZ call and 1 XYZ put, then you are long 2 different XYZ option contracts, 1
call and 1 put.

In this case you are long 2 separate and distinct option contracts. You have the right to buy 100
underlying XYZ shares at the strike price of the call contract, and the right to sell 100 XYZ shares at
the strike price of the put contract. Buying a call in no way involves a put, and buying a put in no way
involves a call.

Consequences of Being Long Options

When you are long an option contract, call or put, you will benefit from any increase in that contract’s
market value. If you can sell the contract for more than your net cost (including commissions), you will
realize a profit. On the other hand, if you sell the long contract for less than your net cost, or if it
expires with no value, you will realize a loss.

If you are long an equity call or put, you have the right to exercise the contract at any time until it
expires. In other words, you are in control; you determine when or if to exercise. In addition, your risk
from purchasing and holding a long call or put option is entirely limited to what you initially paid for it.

“Long” as a Market Expectation

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 The term “long” is also commonly used by investors to describe an overall position in options, stock, or
options in combination with underlying stock, which can be expected to benefit from an increase in
price of the stock. In this respect, the term “long” is synonymous with the term “bullish.”

Consider the following equity option investors:

Investor A Long XYZ Calls Bullish

Investor B Short XYZ Puts Bullish
Investor C Covered XYZ Call Moderately Bullish
Investor D Long 100 XYZ Shares Bullish

Each of these investors can characterize his or her position as “long XYZ.” In other words, each will
benefit if the price of XYZ stock goes up.

Long vs. Short - Continued

What Can “Short” Mean?

“Short” Options

When you sell an option contract, either a call or put, that you don’t currently own, you are “writing”
that contract. In other words, you are then “short” that contract and have taken on the obligation to buy
(in the case of a short put) or sell (in the case of a short call) if you are assigned.

Calls:

If you sell (write) 1 XYZ call, then you are short 1 XYZ call contract.
If you sell (write) 10 XYZ calls, then you are short 10 XYZ call contracts.

In either case, you have the obligation to sell 100 underlying XYZ shares per call option contract if you
are assigned.

Puts:

If you sell (write) 1 XYZ put, then you are short 1 XYZ put contract.
If you sell (write) 10 XYZ puts, then you are short 10 XYZ put contracts.

In either case, you have the obligation to buy 100 underlying XYZ shares per put option contract if you
are assigned.

Calls and Puts:

If you sell (write) 1 XYZ call and 1 XYZ put, then you are short 2 XYZ option contracts, 1 call
and 1 put.

In this case you are short 2 separate and distinct option contracts. You have the obligation to sell 100
underlying XYZ shares at the strike price of the call contract if assigned, and the obligation to buy 100
XYZ shares at the strike price of the put contract if assigned. Selling (writing) a call in no way involves
a put, and selling (writing) a put in no way involves a call.

Consequences of Being Short Options

When you are short an option contract, call or put, you will benefit from any decrease in that contract’s

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 market value. If you can buy the contract for an amount less than you initially received from its sale
(including commissions), or if it expires with no value, you will realize a profit. On the other hand, if you
buy the contract for more than you initially received when selling it you will realize a loss.

If you are short an equity call or put, you are not in control of when or if you will be assigned.
Assignment may occur at any time until the short contract expires. Your risk from selling (writing) a
short, uncovered call is theoretically unlimited. Your risk from selling (writing) a short, uncovered put is
potentially a substantial amount.

Note: A short option position might be “covered,” or your risk limited, by either an existing and
equivalent underlying stock position (i.e., 100 shares per contract), or a long option of the same type
on the same underlying stock. The fact that the short option is covered has no impact on your possible
assignment. In other words, you may still be assigned.

“Short” as a Market Expectation

The term “short” is also commonly used by investors to describe an overall position in options, stock,
or options in combination with underlying stock, which can be expected to benefit from a decrease in
price of the underlying stock. In this respect, the term “short” is synonymous with the term “bearish.”

Consider the following equity option investors:

Investor A Long XYZ Puts Bearish

Investor B Short XYZ Calls Bearish
Investor C Short 100 XYZ Shares Bearish

Each of these investors can characterize his or her position as “short XYZ.” In other words, each will
benefit if the price of XYZ stock goes down.

To Summarize

As you can see, the context in which the words “long” vs. “short” are used should help clarify any
confusion about the sense in which they are being used. If you see or hear these words used in a
context in which you don’t clearly understand their implication, such as when you’re getting investment
advice, then by all means check with your broker before moving into the marketplace to make a trade.

Equity Call Exercise & Assignment for Dividends

Before reading on you should first have a good understanding of both the terms and specifications of
an equity call contract. If you don’t, then you can learn about them elsewhere on this website. With this
knowledge in hand, in this class you can learn about:

Early exercise of a long equity call option in order to be paid an underlying dividend

Early assignment on a short equity call option before an underlying dividend payment

Important dates for dividends

Long Equity Call Owners & Underlying Dividends

The owner of a long equity call option has bought the right to buy underlying stock. The call owner
does not own the stock, and so does not have the privileges of underlying shareholders, like voting
rights and receiving dividend payments (if any are made). Therefore, if a long call owner does in fact
want to receive a dividend then he must exercise the call, purchase the underlying stock, and do so on

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 a timely basis.

Before we consider circumstances that might prompt a long call owner to exercise for this reason, let’s
first briefly consider the stock settlement process as it relates to important dates surrounding dividend
payments. By dividends we mean cash payments made to shareholders on a regular basis, usually
quarterly.

Stock Settlement & Dividend Dates

Monday Tuesday Wednesday Thursday Friday

4th 5th 6th 7th 8th
Buy Stock & Buy Stock &
Receive Dividend Do Not Receive Dividend

Stock Settlement

Stock transactions are settled on a “T+3” basis. In other words, shares will officially change hands 3
business days after the transaction date. You are, however, free to sell the stock before the 3-day time
period is over. On the third day after buying stock, the company issuing the shares will have entered
you as a shareholder on its record books. You then become a “holder of record” of its stock.

Record Date

In order to receive a dividend, a stock owner must be a holder of record on the dividend’s record date,
and so must have purchased stock at least 3 business days beforehand.

Ex-Dividend Date

The ex-dividend date, or “ex-date,” is 2 business days before the record date. From this day forward, a
stock buyer will not be eligible to receive the upcoming dividend because he will not become holder of
record in time.

Stock Buyer Eligibility for Dividend Payment

To qualify for receiving an upcoming dividend payment, a stock buyer must have purchased shares no
later than the day before the ex-dividend date. By doing so, he will become holder of record in time.

Exercising a Call Option for Dividend Payment

Again, for a long call owner to qualify for a dividend payment he must exercise the call and buy
underlying shares, and do so on a timely basis. To become a stock holder of record by a dividend’s
record date, a long call holder must therefore exercise the call to buy the shares no later than the
business day before the dividend’s ex-date. By doing so, he will become holder of record in time;
remember T+3.

Exercise for Dividend or Not?

Do all long call owners exercise their contracts early (before expiration) to receive an underlying
dividend payment? No, not all. There are, however, certain circumstances in which you might consider
it. The financial justifications for doing so will vary among investors and option professionals, but let’s
consider two general scenarios.

Deep In-the-Money Calls

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 If your long call is very deep in-the-money, its premium contains no time value, and its price moves
tick-for-tick with the underlying stock price, then you might consider exercise. On the ex-dividend date,
the underlying stock paying the dividend will open down by the dividend amount. In other words, the
stock will trade “without the dividend.” The price of the deep in-the-money call as described above
could also be expected to open down by the same amount.

To offset the loss you might see in your call in this case, you could exercise the option on the day
before the ex-dividend date, buy the stock and receive the same dividend amount to theoretically
break-even.

In-the-Money Calls with Time Value

A call not so deep in-the-money and with time value left in its market price is a different matter. In
general, you might consider exercising such a call to receive an upcoming dividend when the time
value portion of its market price is less than the amount of the dividend, and expiration of that call is
relatively near. The logic might be that even though you give up its time value when you exercise a call
early, this loss is more than offset by the dividend you’d receive.

Assignment Before a Dividend?

If you happen to be short an equity call that is in-the-money, and there is an upcoming dividend
payment, you might begin to prepare for assignment in the scenarios described above. After all, if long
call holders exercise their contracts, then call sellers (writers) will be assigned.

Consequences of Early Call Exercise

If you’re thinking about an early call exercise for a dividend then there are other factors that should be
considered. When you exercise a call you’re replacing that option position with a long stock position,
so you should also take into account interest and stock risk.

There is an interest cost in owning stock that you would incur for one of two reasons. First, if you buy
stock on margin you are in effect borrowing some of the purchase price from your brokerage firm. You
will begin to pay interest on the borrowed funds right after the stock is bought. If not buying the stock
on margin then you would pay cash for it and give up the interest that cash could otherwise be earning
you.

As for stock risk, remember that as a long call owner your maximum downside loss is entirely limited to
the price you initially paid for the call. The maximum downside loss on long stock is substantially more
– the total value of the stock. In theory, it could decline to zero.

Consult with your Broker before Early Exercise

This class establishes only a few typical considerations for early exercise of a long call for an
underlying dividend. It is in no way to be construed as advice in any specific situation. For that you
should consult with your broker and/or financial advisor. Ultimately, you should take into account your
particular financial circumstances as well as your tolerance for risk.

Equity Call Exercise or Assignment

Before reading on you should first have a good understanding of both the terms and
specifications of equity call contracts. If you don’t, then you can learn about them elsewhere on
this website. With this knowledge in hand, in this class you can learn about exercise or
assignment on a short equity call option position: the resulting underlying stock transaction
and it how it affects you financially. You will learn:

Your net cost for buying underlying shares through exercise of a long equity call

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 The net cash amount received for selling underlying shares through assignment on a short
equity call

When you might exercise a long call, or be assigned on a short call, before expiration

How exercising, or an assignment on an equity call might impact an existing position in the
underlying stock

Exercising a Long Equity Call

An equity call option gives its buyer (owner) the right to buy 100 underlying shares, at the strike price
per share, upon exercise of that long contract. This right is specified in the contract’s terms. Let’s
check out the numbers for both buying and exercising a long equity call contract.

Buy Call

Say you buy an XYZ June 50 call for $3.50. Since equity option premiums are quoted on a per
underlying share basis, your total cost for the call would be the quoted $3.50 premium amount x 100
underlying shares, or $350.00 total, plus the commission you paid to buy the call in the first place.

$3.50 premium x 100 shares = $350.00 total premium paid + commission

After you buy the call you can always sell it before it expires, if it has market value, to realize a profit or
cut a loss. Alternatively, you can exercise the contract at any time before it expires to buy underlying
stock.

Exercise Call & Buy 100 Shares

Now you exercise the XYZ June 50 call and buy 100 shares of XYZ at the strike price of $50 per
share, or $5,000 total. Of course, when you take delivery of the 100 shares in your brokerage account
you’ll need to pay for them. Depending on your account type, you might be required to pay the total
$5,000 for the stock, or to cover the margin requirement which would be less. Your brokerage will also
generally charge a fee for each contract exercised.

$50 strike price x 100 shares = $5,000 total + exercise fee

Effective Cost for Shares after Exercise

But remember, you paid a premium amount of $3.50 per underlying share for the call, and that this
premium paid is considered non-refundable. So for profit or loss consideration, your effective net cost
basis for the stock is therefore strike price + premium paid for call, or $50 strike + $3.50 premium =
$53.50 net per share. For all 100 shares purchased your total effective cost would be $5,350 plus
exercise fee.

$50 strike price + $3.50 premium = $53.50 net per share = $5,350 total + exercise fee

Exercise or Not?

As a long equity call holder you have the right to exercise the contract at any time before it expires.
Before expiration however, investors generally choose to sell their long call contracts to realize a profit,
or cut a loss. The reason is that any time value remaining in the option’s price would be lost by
exercising early. Some exceptions to this general rule might be if the underlying stock is going to pay a
dividend soon and expiration is relatively near, or if there is a tender offer for the shares as a result of a
buy-out or takeover of the corporation who issued the underlying stock. In either case, you should
check with your broker on the advisability of early exercise.

At expiration, however, all time value will have eroded away. So as the market closes on expiration
Friday, if you have a call contract that’s in-the-money you’ll need to decide whether to exercise or sell

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 it.

If you initially bought the call to profit from an increase in its value then selling the contract makes
sense. Beware of exercising an in-the-money call on expiration Friday with the expectation to profit
from selling the stock in the market on Monday, for two main reasons. First, you’ll pay an additional
commission for the stock sale. Second, and more importantly, you have market risk over the weekend.
On Monday the stock could open down, or drop in value before you have a chance to sell your shares.

On the other hand, if you bought the call with the intention of exercising it to buy underlying stock, or if
you’ve decided after the call’s purchase that want to own the underlying stock for a while, then it would
make sense to exercise the option. In either case, you must be willing and able to pay for 100 shares
per call contract exercised.

Existing Position in the Underlying Stock

If you’re long a call contract in a brokerage account that has a short position in the same underlying
stock, then the number of shares you buy from exercising the call will generally be used to close, or
“cover,” an equivalent number of your short shares. Check with your brokerage firm about its policies
and procedures on this matter.

Equity Call Exercise or Assignment - Continued

Assignment on a Short Equity Call

An equity call option conveys to its writer (seller) the obligation to sell 100 underlying shares, at the
strike price per share, if assigned on that short contract. This obligation is specified in the contract’s
terms. Let’s check out the numbers for both selling (writing) and assignment on a short equity call
contract.

Write (Sell) Call

Say you sell an XYZ June 50 call for $3.50. Since equity option premiums are quoted on a per
underlying share basis, the total cash you receive for the call would be the quoted $3.50 premium
amount x 100 underlying shares, or $350.00 less the commission you paid to sell the call in the first
place.

$3.50 premium x 100 shares = $350.00 total premium received – commission

After you sell the call you can always buy it back (close the position) before it expires to realize a profit
or cut a loss. In the meantime, you can be assigned on the short contract at any time before its
expiration and be obligated to sell underlying stock.

Assignment on Call & Sell 100 Shares

Now you’re assigned on the short XYZ June 50 call and sell 100 shares of XYZ at the strike price of
$50 per share, or $5,000 total. Of course, after you’ve sold the 100 shares you’ll receive the cash from
their sale in your brokerage account. Your brokerage will also generally charge a fee for each contract
assigned.

$50 strike price x 100 shares = $5,000 total – assignment fee

Effective Proceeds Received for Shares after Assignment

Remember, you received a premium amount of $3.50 per underlying share for the call, and that this
premium is yours to keep whether you’re assigned or not. So for profit or loss consideration, the
effective net proceeds received for the stock is therefore strike price + premium received for call, or

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 $50 strike + $3.50 premium = $53.50 net per share. For all 100 shares sold your total effective
proceeds would be $5,350.

$50 strike price + $3.50 premium = $53.50 net per share = $5,350 total – assignment fee

Assignment or Not?

Before expiration you can be assigned at any time, but you might generally expect early assignment in
two situations: if the underlying stock is going to pay a dividend soon and expiration is relatively near,
or if there is a tender offer for the shares as a result of a buy-out or takeover of the corporation who
issued the underlying stock. At expiration, however, you can expect assignment on any short call that
is expiring in-the-money. As for at-the-money contracts, assignment is possible but not certain. This
uncertainty is called “pin risk” in the options industry, and it refers to the uncertainty of assignment
when the underlying stock price is “pinned,” or closes at the call’s strike price at expiration.

In any of the cases above, you should check with your broker on your alternatives to avoid assignment
if you’d find that unacceptable.

Existing Position in the Underlying Stock

If you’re short a call contract in a brokerage account that has a long position in the same underlying
stock, as in a covered call, then the number of shares you sell after assignment will generally be used
to reduce your long stock by the equivalent share amount (100 shares per assigned option contract).
Check with your brokerage firm about its policies and procedures on this matter.

Commissions & Fees

Brokerage firms charge commissions for each option purchase or sale, and these costs vary from firm
to firm. In addition, brokerage firms generally charge fees for each option exercise or assignment.
These fees will also vary, but are often about the same as the commission for an option transaction.
Both of these costs should be included in any calculations of profit or loss from your call purchase or
sale, as well as any exercise or assignment. Check with your brokerage firm about its particular
schedule for these transaction costs and fees before you enter the marketplace.

Equity Put Exercise or Assignment

Before reading on you should first have a good understanding of both the terms and
specifications of equity put contracts. If you don’t, then you can learn about them elsewhere on
this website. With this knowledge in hand, in this class you can learn about exercising or
assignment on an equity put option position: the resulting underlying stock transaction and it
how it affects you financially. You will learn:

The net cash amount received for selling underlying shares through exercise of a long equity
put
Your net cost for buying underlying shares through assignment on a short equity put
When you might be assigned on a short put, before expiration
How exercising, or an assignment on an equity put might impact an existing position in the
underlying stock

Exercising a Long Equity Put

An equity put option gives its buyer (owner) the right to sell 100 underlying shares, at the strike price
per share, upon exercise of that long contract. This right is specified in the contract’s terms. Let’s
check out the numbers for both buying and exercising a long equity put contract.

Buy Put

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 Say you buy an XYZ March 70 put for $4.50. Since equity option premiums are quoted on a per
underlying share basis, your total cost for the put would be the quoted $4.50 premium amount x 100
underlying shares, or $450.00 total, plus the commission you paid to buy the put in the first place.

$4.50 premium x 100 shares = $450.00 total premium paid + commission

After you buy the put you can always sell it before it expires, if it has market value, to realize a profit or
cut a loss. Alternatively, you can exercise the contract at any time before it expires to sell underlying
stock.

Exercise Put & Sell 100 Shares

Now you exercise the XYZ March 70 put and sell 100 shares of XYZ at the strike price of $70 per
share, or $7,000 total. Of course, after you’ve sold the 100 shares you’ll receive the cash from their
sale in your brokerage account. Your brokerage firm will also generally charge a fee for each contract
exercised.

$70 strike price x 100 shares = $7,000 total – exercise fee

Effective Proceeds Received for Shares after Exercise

Remember, you paid a premium amount of $4.50 per underlying share for the put, and that this
premium paid is considered non-refundable. So for profit or loss consideration, the effective net
proceeds received for the stock is therefore strike price – premium paid for put, or $70 strike – $4.50
premium = $65.50 net per share. For all 100 shares sold your total effective proceeds would be
$6,550.

$70 strike price – $4.50 premium = $65.50 net per share = $6,550 total – exercise fee

Exercise or Not?

When you exercise a long equity put contract you will sell 100 shares of the underlying stock. If you
have no long position in the stock (don’t currently own the shares), you must either buy the stock in the
market for delivery, or be willing to take a short position in the equivalent number of shares. Check with
your broker about your account’s eligibility, the cash margin requirements and costs for your choices in
a put exercise.

Existing Position in the Underlying Stock

If you’re long a put contract in a brokerage account that has a long position in the same underlying
stock, then generally the number of shares you sell from exercising the put will be delivered to the
person who is ultimately assigned, and therefore obligated to buy them. In other words, your existing
long stock position will be reduced by that number of shares. Check with your brokerage firm about its
policies and procedures on this matter.

Equity Put Exercise or Assignment - Continued

Assignment on a Short Equity Put

An equity put option gives its writer (seller) the obligation to buy 100 underlying shares, at the strike
price per share, if assigned on that short contract. This obligation is specified in the contract’s terms.
Let’s check out the numbers for both writing and assignment on an equity put contract.

Write (Sell) Put

Say you sell an XYZ March 70 put for $4.50. Since equity option premiums are quoted on a per

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 underlying share basis, the total cash you receive for the put would be the quoted $4.50 premium
amount x 100 underlying shares, or $450.00 less the commission you paid to sell the put in the first
place. Your brokerage firm will also generally charge a fee for each contract assignment.

$4.50 premium x 100 shares = $450.00 total premium received – commission

After you sell the put you can always buy it back (close the position) before it expires to realize a profit
or cut a loss. In the meantime, you can be assigned on the short contract at any time before its
expiration and be obligated to buy underlying stock.

Assignment on Put & Buy 100 Shares

Now you’re assigned on the short XYZ March 70 put and buy 100 shares of XYZ at the strike price of
$70 per share, or $7,000 total. Of course, when you take delivery of the 100 shares in your brokerage
account you’ll need to pay for them. Depending on your account type, you might be required to pay the
total $7,000 for the stock, or to cover the margin requirement which would be less.

$70 strike price x 100 shares = $7,000 total + assignment fee

Effective Proceeds Received for Shares after Assignment

Remember, you received a premium amount of $4.50 per underlying share for the put, and that this
premium is yours to keep whether you’re assigned or not. So for future profit or loss consideration,
your effective net cost basis for the stock is therefore strike price – premium received for put, or $70
strike – $4.50 premium = $65.50 net per share. For all 100 shares purchased your total effective cost
would be $6,550.

$70 strike price – $4.50 premium = $65.50 net per share = $6,550 total + assignment fee

Assignment or Not?

Before expiration you can be assigned at any time, but you might expect early assignment when your
short put is deep in-the-money, with no time value left in its market price and expiration is relatively
near. At expiration, however, you can expect assignment on any short put that is expiring in-the-
money. As for at-the-money contracts, assignment is possible but not necessarily predictable. This
uncertainty is called “pin risk” in the options industry, and it refers to the uncertainty of assignment
when the underlying stock price is “pinned,” or closes at the put’s strike price at expiration.

Existing Position in Underlying Stock

When you are assigned on a short equity put your obligation is to buy 100 shares of underlying stock,
and you must take delivery of it regardless of any existing stock position. If you are currently short a
number of shares equivalent to each put you are assigned on (100 shares per put) then your short
stock position will be reduced (covered) by that number of shares when you buy the stock. Check with
your broker about your account’s eligibility, the cash margin requirements and costs for your choices
regarding a put assignment.

Commissions & Fees

Brokerage firms charge commissions for each option purchase or sale, and these costs vary from firm
to firm. In addition, brokerage firms generally charge fees for each option exercise or assignment.
These fees will also vary, but are often about the same as the commission for an option transaction.
Both of these costs should be included in any calculations of profit or loss from your put purchase or
sale, as well as any exercise or assignment. Check with your brokerage firm about its particular
schedule for these transaction costs and fees before you enter the marketplace.

Assignment on a Short Equity Option

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 Before reading on you should first have a good understanding of both the terms and
specifications of equity call and put contracts. If you don’t, then you can learn about them
elsewhere on this website. With this knowledge in hand, in this tutorial you can learn about
being assigned on a short equity option position: both the mechanics and consequences of
assignment. You will learn:

How and when you may be assigned on a short equity call or put
The mechanics of the assignment and the subsequent settlement process
Your obligation to buy (for a short put) or sell (for a short call) underlying shares

American-Style Contract

All regular equity call and put options are American-style contracts, which means you may be assigned
on short positions at any time before they expire. An equity option contract literally expires on the
Saturday immediately following the third Friday of its expiration month.

Mechanics of Being Assigned

First of all, you can only be assigned on an option that you have written, in other words a short call or
short put position. You are not assigned on long option positions. Moreover, you are not in control of
when you might be assigned. The owner (buyer) of a long equity option has the right to exercise at any
time before expiration, and so it follows that the writer (seller) of a short equity call or put can be
assigned at any time before the short position expires.

When the owner of a long call or put makes the decision to exercise an equity option, he tenders an
exercise notice to his brokerage firm, i.e., notifies the firm of his intention to do so.

Once the firm receives the exercise instructions it will in turn notify The Options Clearing Corporation
(OCC) of the long option owner’s intention to exercise. During the evening on the day of exercise OCC
will select through a random process one it customers, like a brokerage firm, with a customer who has
a short position in the specific contract being exercised. Through a procedure of its own that firm will in
turn assign the exercise notice to one of its customers, perhaps you, with a short position in that
contract.

The next business day, generally before the opening of the market, you will receive notification from
your broker that you have been assigned. This notification may come in various forms, perhaps
through a phone call or an email. Check with your brokerage firm about its method and timing of
notifying you. Once you’ve been assigned you’ll find 100 shares of underlying stock sold from your
brokerage account for each short call assigned, with the total cash received from this sale credited. On
the other hand, after assignment on a short put you will find 100 shares purchased with the cash
required for that purchase debited from your account.

Note: Once you have been assigned, this assignment is effective, and you have the obligation to sell
(for a short call) or buy (for a short put) underlying shares, whether you have received notification from

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 your brokerage firm or not. In other words, if your firm cannot reach you for some reason you are still
assigned.

Early Assignment

Exercising a long equity call any day before expiration Friday is called “early exercise,” and so
assignment on a short option before expiration is called “early assignment.”

Assignment at Expiration

Again, the last day an expiring long equity call or put can be exercised is generally the third Friday of
the expiration month, the day immediately before Saturday on which the contract literally expires. The
subsequent exercise & assignment process will occur over the weekend. If you are assigned at
expiration, you will generally find the obliged sale (for a short call) or purchase (for a short put) of
underlying shares posted to your brokerage account on the next business day, generally the following
Monday. If you have access to your brokerage account activity online you might possibly find out
before Monday morning if you’ve been assigned on any short call or put positions.

Anticipating Assignment at Expiration

Generally, you might expect to be assigned on any short equity call or equity put that expires
in-the-money by any amount. That is to say the option is in-the-money compared to the closing price of
the underlying stock on the day before expiration, or expiration Friday. This is not a given, just a
generalization. It is even possible to be assigned on a short equity option that expires exactly
at-the-money or slightly out-of-the-money. Sometimes option professionals will exercise such long
equity contracts to buy or sell underlying stock in order to adjust the risk of large option positions.

Avoiding Assignment

In order to avoid assignment on a short equity call or put position, either early or at expiration, you
must buy (to close) the contract(s) in the marketplace before you are assigned, whether you’ve
actually received your assignment notification from your brokerage firm or not. This is called a closing
purchase transaction, and it terminates your obligation to sell (for a short call) or buy (for a short put)
underlying shares according to the option contract’s terms.

Before expiration, once you’ve bought (or closed) a short equity call or put position you cannot be
assigned on that day, or any day thereafter. If you close an expiring short equity option position by the
close of the option market on its last trading day, which is generally expiration Friday, you can avoid an
assignment at expiration.

Remember that any option contract that expires unexercised ceases to exist, and so becomes
worthless. Once a short option position expires without your having been assigned, your short option
obligation to buy or sell underlying stock expires (or terminates) as well.

Exercising a Long Equity Option

Before reading on you should first have a good understanding of both the terms and
specifications of equity call and put contracts. If you don’t, then you can learn about them
elsewhere on this website. With this knowledge in hand, in this tutorial you can learn about
exercising a long equity option: both the mechanics and consequences of doing so. You will
learn:

How and when you may exercise a long equity option

The mechanics of the exercise and the subsequent settlement process
The result of exercising to buy (for a call) or sell (for a put) underlying shares

American-Style Contract

All regular equity call and put options are American-style contracts, which means they may be

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 exercised at any time (i.e., on any business day) before they expire. An equity option contract literally
expires on the Saturday immediately following the third Friday of its expiration month. The final day
you can exercise a contract is the Friday just before expiration, commonly referred to as “expiration
Friday.” If this Friday is an exchange holiday, then the last day for exercise is the business day before,
or Thursday.

Mechanics of Exercising an Equity Option

First of all, you can only exercise an option that you own, in other words a long call or long put
position. You do not exercise short option positions.

When you make the decision to exercise an equity option, your next step is to tender an exercise
notice to your brokerage firm, i.e., notify your brokerage firm of your intention to do so. Depending on
the firm’s procedures, this notification may require a phone call, or may possibly be sent by electronic
message through its website. Different brokerage firms may have different rules and procedures for
receiving exercise notices from its customers, so be familiar with your firm’s rules in this regard.

Once the firm receives your exercise instructions it will in turn notify The Options Clearing Corporation
(OCC) of your intention to exercise. During the evening on the day you exercise, OCC will select
through a random process one of its customers, like a brokerage firm, with a customer who has a short
position in the specific contract being exercised. Through a procedure of its own, that firm will in turn
assign your exercise notice to one of its customers with a short position in that contract.

The next business day, generally before the opening of the market, you will find 100 shares of
underlying stock purchased in your brokerage account for each call exercised, with the total cash
required for that purchase debited from your account. On the other hand, after exercising a put you will
find 100 shares sold from your account with the cash received from this sale credited.

Early Exercise

Exercising a long equity call any day before expiration Friday is called “early exercise.” Each
brokerage firm may have a different cut-off time (deadline) for receiving your early exercise
instructions, but these times are generally at some point after the option markets have closed for the
day. Become familiar with your firm’s particular rules.

Exercise at Expiration

Again, the last day you may exercise an expiring equity call or put is expiration Friday, the day before
the contract literally expires. On this day your brokerage firm’s cut-off time for receiving your exercise
instructions will generally be different from that for early exercise, so learn what it is. As well, the firm’s
rules and procedures for exercising equity calls at expiration will generally differ from those for early
exercise.

Exercise By Exception

OCC has developed a procedure known as “ exercise by exception” to expedite its processing of
exercises of certain expiring options. Ordinarily under this procedure, which is sometimes referred to

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 as "ex-by-ex," OCC has established in-the-money thresholds, and every contract for which ex-by-ex
procedures apply that is at or above its in-the-money threshold will be exercised automatically.
Currently, for expiring, regular equity call and puts this in-the-money threshold is $0.01. In other words,
any equity option in-the-money by $0.01 (1¢) or more is subject to an automatic exercise by OCC at
expiration.

NOTE: if you have an expiring long call or put, ex-by-ex does not relieve you of your obligation to
tender an exercise notice to your brokerage firm if you desire to exercise your option. Thus, most firms
require notification from their customers of their intention to exercise, even if an option is in-the-money.
You should ask your firm to explain its exercise procedures, including any deadline the firm may have
for exercise instructions on the last trading day before expiration.

Important to understand:

OCC does have discretion as to which options are subject to, and may exclude other options
from, the ex-by-ex procedure.
You should note that ex-by-ex is not intended to dictate which customer positions should or
should not be exercised.

Do You Have to Exercise?

Given OCC’s established ex-by-ex procedures, do you have to exercise long calls or puts expiring
in-the-money by the threshold amount of $0.01 or more? No. You also have the right to:

exercise some of your long options expiring in-the-money by the threshold or more
exercise none of your long options expiring in-the-money by the threshold or more

Exercising Expiring Long Options Contrary to Ex-by-Ex Procedures

You have the right to exercise any or all of your long option contracts that are expiring in-the-money by
less than OCC’s ex-by-ex $0.01 threshold if you want. You also have the right to exercise long
contracts expiring exactly at-the-money, or even out-of-the-money contracts if you find reason to do so.

NOTE: For exercising, or choosing not to exercise, any expiring equity option contracts contrary to
OCC’s ex-by-ex procedures, your brokerage firm may require you submit detailed instructions on a
specific form and before a specific cut-off time for doing so.

Exercise Instructions are Irrevocable

Once your brokerage firm has submitted to OCC your exercise instructions for either early exercise or
exercise at expiration, these instructions are irrevocable. At that point you cannot change your mind.
Mistakes in this regard can be costly.

Be Diligent

Remember, any option contract that expires unexercised ceases to exist, and so becomes worthless.
You cannot exercise an expiring long contract after the cut-off time for doing so on expiration Friday.

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