Options Expiration & Assignment

The text is the output of AI-based and/or outsourced transcribing from the audio and/or video recording. Although the transcription is largely accurate, in some cases, it is incomplete or inaccurate due to inaudible passages or transcription errors and should not be treated as an authoritative record. This transcript is provided for educational purposes only. Nothing that you read here constitutes investment advice or should be construed as a recommendation to make any specific investment decision. Any views expressed are solely those of the speaker and should not be relied upon to make decisions.

In this video, we're going to go through the entire options expiration and assignment process, and basically give you a rundown on everything that you need to know.

And that's jointly owned by all the exchanges that trade options, and they issue all the options and control all the controls and effects all exercises and assignments.

And what's really important to understand about the OCC is that they guarantee all trades by acting as a counter party to any purchase or sale of options, thereby providing a liquid market for trading.

Now, I'll get to a little graph here in a second that describes what OCC is. But again, it's their acting as a counter party to guarantee all trades.

They're not acting as the other person that you're trading with. So, for example, if you're an option buyer, you're not buying options directly from the OCC. They're not going to be the other party involved.

You're still going to be buying options from an option seller, but the OCC is going to be the person in between there that guarantees that if one party doesn't pay or can't provide payment that the other party has made whole.

So that you know that if you buy an option or sell an option, and make money on that trade, that someone is going to be there to pay those profits to you.

So the OCC, like other clearing companies, is the direct participant in every purchase and sale of an option contract. They act as kind of the "go between," they kind of "barrier" between an option buyer and option seller. But again, they guarantee everything, that's what's really important here.

So, here's a quick little graphic we've gone over before, but it's worth going over again. Again, if you are an option buyer, in this case, then what you want to do is you would want to submit payment to the OCC.

Okay, again, they are acting as not the middle man but as the clearing part of it to guarantee the trade. They give that payment to the option writer or the option seller.

The option writer then gives the OCC their option contract, which then delivers the option contract to you. Now, this all happens in a split second, right? And everything that we do in options trading happens in a split second.

But in the case of this video, what's important to know is that there is an intermediary here that guarantees payment and liquidity. So there's an option writer and an option buyer, or an option seller and an option buyer doesn't matter, someone is going to be there to guarantee that if this person decides if they can't pay ...

Don't have enough money in their account, whatever the case is, for some weird reason that they can't do it, OCC will make you whole. And that's the key part here. Now remember, options are expiration dates.

We usually show these here at Option Alpha with vertical lines on our chart. There's ways you can do that on a lot of different broker platforms; I like to visually see it by showing these vertical green or vertical red lines on my chart. But you can consider this kind of like the make or break points.

For right now, the time that we did this video, we took this screenshot here of a stock, and you can see this is where it's trading. And basically, these are the different options' expiration dates. So we could have the monthly dates, you could have weekly dates.

But basically, this is the time frame you need the stock to move before you could either make money or not. That's what's really important about option expiration dates.

Again, we've got a great little calendar and resource guide here on Option Alpha that you can download. We usually have this current year plus a couple of current years out into the future if you've ever wanted to check that out.

Again, it's completely free. The one that we use gives you all of the market holidays as well so its very easy so, for example, January 1, that's New Year's, that's going to be a market holiday, and then we've got March if there's a market holiday there, whatever the case is.

And it also gives you the expiration dates for the monthly contracts and the quarterly contracts. So in this case this is going to be the actual expiration date for monthly contracts in January, again it's all the third Friday of the month for the monthly contracts, that's the expiration date.

The expiration date, or the day they expire, and everything transfers over is that following Saturday, so that always happens on the following Saturday. So again, cool resource again 100% free here at Option Alpha.

So, a couple of little quick tips before we get into the exercise and assignment process for options. Again, expiration day for equity and index options is the Saturday immediately following the third Friday of the expiration month (except obviously when Friday's a holiday, in which case it was brought forward by one day to Thursday).

Okay, so again you can check our calendar that we have, it's always there. But actual options expire on Saturday, the last day they can trade is Friday. Most people consider Friday the last expiration day.

So again, for American-style index options contracts, the last trading day is the third Friday, again unless it's a holiday in which case it brings forward to Thursday.

For European-style index option contracts, and again we'll get into all this here later on in the video, but it's important to not right off the bat, the last trading day will the business day, generally Thursday, preceding the day in which exercise settlement value is calculated.

An American-style options may be exercised at any time before its expiration, and at anytime up to an including the third Friday of the expiration month. That's why third Friday is always considered to be the last trading day.

So you can see here, back on our calendar, basically, American-style options can be exercised, assigned anytime including that last Friday. So, last Friday of the expiration cycle is usually the time where you want to get something done or make a change.

A European-style index option may only be exercised during a specific period, just before its expiration. Now, this is the last Friday.

Now we'll get into the differences between European and American style options, but I wanted to introduce this real quick because I think most people gloss over it, and I want to make sure we have clear understanding that there are differences in American-style versus European-style.

And it's not necessarily that those are American options on the American market versus European options on the European market, it's a style of contract, okay?

So first, before we get into that, let's talk through the actual options exercise process. Now, this is really important because you have to clearly, clearly understand what happens if you decide to exercise your option.

Now there are tow different things we have to talk about right? There's the options exercise, and then options assignment. Exercising an option is when you are an option buyer, and you decide to exchange your option contract for the actual shares of underlying stock.

In this case, we'll use a call option in both examples. Now option assignment, which we'll talk about here next, that's when you are the option seller, and the option buyer has decided to exercise their contract, and now you have to give up your shares of the actual underlying option, okay?

So that's what's really important here as we go through. Now options exercise obviously starts with a call option holder or call option buyer, or put option holder or put option buyer, deciding to exercise their contract.

So, whatever that happens, with American-style options, which is 90% of the market, 95% of the market, that's going to happen at anytime until expiration. So whenever that person decides "I want to go ahead and exercise my option, they submit that request to their broker," okay?

Now that can in the form a phone call; it can usually come in the form of going into your online account, and choosing the option to exercise the option versus to sell it back to the market, or whatever the case is.

But, whatever they do, they submit that request to their broker, so whoever your broker is, then receives that request. Immediately the broker sends a notice of exercise to the OCC.

So again, this is why I want to talk about the OCC first in this video because now you can see where the OCC comes into play here a little bit more. Now the OCC receives that request immediately, and they randomly select a member firm who is short an exercise call and assign them the exercise.

Now this is the key point, most people assume, sometimes when they get into trading, that when you have a contract with somebody else for the entry, meaning if I buy an option from you, and you're the option seller, that immediately we're tied together, and if you decide to do something that reflects upon me and visa verse, that's not the case, we're jus parties involved for that initial contract.

But what happens in the exercise an assignment process is that it is randomly generated, meaning it's randomly assigned between brokers and the actual call writer. So you don't know if you're going to get assigned somebody's contract or not, it's all randomly done.

So the first thing that happens again is that that OCC randomly selects a member firm, so they can select your firm, or randomly select a different firm. From there, the firm will select on a random basis some of their clients that have those short options.

So again, random firm, check, random assignment of the call seller, okay? And at that point then the call seller will then deliver the shares back through the process, okay?

This is again the options exercise process, this is if you're an option holder, an option buyer, and you decide to convert that option contract into underlying shares whether long or short, all right?

Now, let's go on the other side and talk about the option assignment process. It's all the same stuff, but I just want to talk about it a little bit different. Again, what happens now is that if you are an option writer or an option seller, you will get assigned a contract.

Now you don't know when this is going to happen because it's all random. If you do get assigned a contract, you'll get a notice from your broker that you've assigned. Once that happens, then you'll have to deliver the contract to your broker, right?

And that contract will then be converted into the shares, and the shares will then be delivered to the OCC. So again, we come full circle here, and now the OCC receives the shares that came out of your account.

Remember you got randomly assigned through this process that we just talked about in exercise, and so now that you've been assigned, you deliver the shares to your broker, the broker delivers them to the OCC.

Immediately the OCC then delivers the shares back to your broker, or the option buyer's broker, who then delivers the shares to the option buyer, okay?

So this entire process happens very quickly, and again the parties involved here include the OCC, which happens to be the intermediary, they guarantee everything, they double check everything, and then your brokers act as that direct links to the OCC and between you and the option buyer and option seller, okay?

So again, hopefully, that clears up the entire process of exercise an assignment, and again we'll get through some more stuff here as we get further into this training, all right? Now though options can be exercised or assigned at any point, and we've talked about his before, it's important to remember that the vast, vast majority of options are assigned the week of expiration- and the last few days.

Now this is a big one because even though you can technically be assigned at any point. So, I can choose as an option buyer to assign my contract to you like the option seller at any point; you have to understand that as an option buyer if I sign early, I lose any time value or extrinsic value that that contract has.

And so, that means that most contracts are assigned, or exercised, however you want to look at it. They are assigned or exercised the week of expiration because they are nearing their intrinsic value, they don't have this extra component of volatility and time decay.

Again, if I exercise early, I lose that as an option buyer, and so that's why most option contracts are not exercised incredibly, incredibly early. They're exercised later on in the cycle, the vast majority of that coming the week of expiration and, the last few days, so Wednesday, Thursday, Friday.

So what this means is that you shouldn't worry about expiration of an assignment as you're trading. I think when we went back recently and tracked all of our trades for the last five years, and we've done thousands of trades over the last five years, we were assigned on contracts, I think just over 1%, like 1.2% of the time, we were assigned contracts.

So, it is very rare to happen. And again, you got to deal with stuff the week of expiration, you can't run yourself all the way to the end until the limit, and hold a contract that's in the money the few days of expiration.

You do have to manage that risk obviously, and we teach you how to do that here at Option Alpha. But, as far as numbers go, we've only been assigned about 1.2% of the time over the last five years.

So that gives you a little bit of confidence to know that most of this assignment exercise process doesn't happen all too often. It can happen, and if you trade long enough, it will. But it's not something that you need to freak out about and hyperventilate about.

All right, so let's continue to go through here, we've got a couple more things that we need to cover. First, we need to cover the difference between physical and cash settlement. Now physical settlement is option contracts whereby settlement requires the actual physical delivery of the underlying security.

Most of the options you will find in the marketplace are physically settled options, like stock options, since the underlying stock is transferred and delivered.

Now this is what we've talked about all through Track 1, most of the trading that we do at Option Alpha is regarding physical settlement, where if you are assigned or if you exercise, you want to get or receive the underlying shares of whatever you're trading. So for example here, we have Google stock.

If you're trading Google options, you'd want to get or receive Google shares, okay? Now there is a difference because there are also cash settled options. And these are options/contracts whereby settlement is done via the payment of cash at exercise at expiration.

This is typically the settlement that is preferred when delivering an underlying security that is inconvenient, costly, or simply impossible to give. And you want to think here of the SPX and VIX options.

Most index options are cash settled, and the reason that they're cash settled is that you can't go out and buy an index, you can't go out and buy SPX, it's just a benchmark index. So, although there are options on SPX when actual assignment or expiration comes, you get just the cash value of your options of your contracts at expiration.

So, you either make money or you didn't, there's no actually delivery of the SPX index, because it's nonexistent, it's impossible to deliver the index, okay?

Now most of the stuff that we do here at Option Alpha like I said, is a physical settlement, this does include ETFs, because you can buy ETFs, those are physical securities. But, a lot of things out there are cash settled as well, and it's mostly some of the index: SPX, RUT, VIX, NDX, etc.

Now again, we talked about this before, but it's worth mentioning here again towards the end again, is that there are two different types of options, and it's really important that we distinguish between these.

The first is American options. You can American-style options any time before expiration. So for example, if you own a call option and there are fifteen days before expiration, you can choose to exercise that option and buy the stock at the strike price. Now this is different than European options. European options are only exercised at expiration.

And so most of the index and forex options (again like RUT, SPX, NDX, etc. that we talked about) are typically European-style, and the reason they are is because those are usually cash settled indexes as well because you're not going to do an early exercise of SPX and buy SPX, it's impossible to get delivery of an index. So that's why most of those are European-style.

Again, they're less common, just like cash settlement is less common. Most of the options that are out there are American-style, which means they can be exercised anytime before expiration.

What's real, really important to remember here about American-style options, since this is most of what we do here, is that this is only dealing exercise and assignment. It has nothing to do either European or American-style with the ability to buy or sell contracts.

So, if you have an American-style option or European-style option, you can still buy and sell those contracts all the time, back and forth, as many times as you want, up until expiration.

You can buy a call, sell it back, buy a call, sell it back, buy a put, sell it back, buy a put, sell it back, you can do this all the time. It's only when it comes to the actual exercise of that option where you want to convert a contract into underlying shares, that's where the difference comes in here between American and European styles.

So, hopefully, that makes sense. Again, most of what we do here at Option Alpha is a physical settlement and American-style options, and again, that's the most widely used type of contracts out there.

So, hopefully this has been a really good video tutorial on the entire options expiration, assignment exercise process. Again, I appreciate you taking the time to watch it. If you have any comments or feedback, please leave them in the comment section below.

If you love this video, please help us out by sharing it online, it's one of the ways we spread the word here at Option Alpha. And until next time, happy trading.