Definition
The term exercise refers to the right granted in an options contract which allows the holder to buy or sell the underlying asset. American options allow the holder to exercise this right any time before the contract expires.
Explanation
The right to exercise an option always rests with the holder or the investor taking the long position in the contract. While the holder of a call option has the right to buy the underlying commodity, the holder of a put can exercise their right to sell the underlying commodity. Investors that take a short position in an option are assigned when a holder exercises an option.
When a buyer exercises their option, a notice is sent to the seller of the contract as determined by the Options Clearing Corporation (OCC). When this occurs, the seller is said to be assigned; the process of assignment is random. American options provide the holder with the right, but not an obligation, to exercise their option at any time before its expiration. However, the writer of an option has an obligation to sell or buy the underlying security if assigned. In practice, most options are never exercised by the holder and expire worthless or are eventually closed out.
Related Terms
The term execution refers to a transaction that completes buy or sell orders for a security or futures contract. The execution of an order is typically facilitated by a third party, such as a broker.
Moneyzine EditorNovember 6th, 2024
The term ex-pit transaction refers to a commodity transaction that takes place away from the floor of the exchange where it would normally occur. Ex-pit transactions typically involve the cash market and a private deal between two hedgers.Moneyzine EditorJanuary 17th, 2024- The term price improvement refers to the process of obtaining a lower than offer price when buying a security or a higher than bid price when selling a security. Price improvement is one of the possible outcomes from a broker's duty of best execution.Moneyzine EditorNovember 6th, 2024
- The term payment for order flow refers to the compensation received by brokers from third parties when an order is routed to the third party for execution. Payment for order flow is one of several ways a broker is compensated when an investor places a buy or sell order.Moneyzine EditorNovember 6th, 2024
The term duty of best execution refers to the legal responsibility of a broker to provide the most favorable terms when executing an order on behalf of an investor. Factors a broker should consider under their duty of best execution include price, speed, and likelihood of execution.Moneyzine EditorNovember 6th, 2024
The term assigned refers to the process whereby the writer, or seller, of an option is asked to fulfill their obligation under their contract. When assigned, an option writer has the obligation to either sell or buy the underlying asset at the agreed to price.Moneyzine EditorNovember 6th, 2024
