Series 7: 5.1.7 Settlement: Expiration, Liquidation, Or Exercise

5.1.7  Settlement: Expiration, Liquidation, or Exercise

There are three ways in which an option contract can settle: it can be exercised, traded, or left to expire. If an option is in the money, an option buyer will at some point want to exercise the option or trade it. An option seller will prefer to see the option out of the money, where it will be left to expire.

Exercise. Remember that an American-style option can be exercised at any time. When the buyer exercises the option, the seller is said to be assigned the option. Assignment means the seller has been selected to purchase the underlying stock at a loss and deliver it to the buyer. When an option is exercised, settlement occurs on the second business day following the exercise date, or trade date (E + 2 or T + 2). This is the date when payment is made.

Liquidation/trade. When you