Exercise and assignment
What physically happens when someone uses their right — and what it feels like to be the person on the other end.
Exercise is the buyer using their right. Assignment is the writer being required to honour it. Every exercise creates an assignment for somebody.
Two styles
- American style. Can be exercised on any day up to expiry. Most options on individual shares work this way.
- European style. Can only be exercised at expiry. Common for options on indices.
The names are historical and have nothing to do with geography.
What actually changes hands
For options on shares, exercise usually means real shares move. A call buyer who exercises pays the strike and receives 100 shares per contract; the assigned writer delivers them.
For index options there are no shares to deliver, so they settle in cash — the difference is simply paid.
The thing that surprises people
Most brokers automatically exercise options that finish in the money by more than a small threshold. A holder who forgot about the position can wake up owning — or owing — 100 shares per contract, and needing the cash to settle it.
If you hold a call on a $200 share and it expires in the money, automatic exercise may require $20,000 per contract. The broker will not ask first.
Early assignment
As a writer of an American-style option, you can be assigned on any trading day, without warning. It is not personal and it is not predictable — assignment is allocated among writers by the clearing house.
It becomes likely precisely when the option is deep in the money, which is to say when the position has already gone badly against you. The mechanics and the bad news arrive together.
How to avoid the whole business
Most options are never exercised at all — they are closed by trading the contract back before expiry. Selling the option you bought, or buying back the option you wrote, ends the position and removes any question of delivery.