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 holder exercises the option, the writer is said to be assigned the option. Assignment means the writer of the option must do what he committed to when he sold the option: for a put, the writer must buy the underlying stock from the holder at the strike price; for a call, the writer must sell the underlying stock to the holder at the strike price. When an American-style option is exercised, settlement occurs on the second business day following the exercise date, or trade date