There are a few different ways your stock options can meet their logical end. In many options strategies, it might make sense for you to buy to close or sell to close your option contract(s). However, there are also scenarios where you might prefer to let your contracts expire worthless, or even exercise your option to buy or sell the underlying stock. Here's our beginner's guide to options expiration, assignment, and exercise.
If you're trading traditional monthly equity options, expiration will fall on the Saturday following the third Friday of each month. Weekly options are typically listed each Thursday and expire on Friday of the following week (although no weeklies are offered during the expiration week for monthly options). In both cases, that final Friday is your last chance to take action on the trade. Otherwise, the market will decide your course of action for you.
If your option is out-of-the-money on expiration Friday, you might simply choose to let the contract expire worthless. There will be very little time value remaining at this point for you to capture, so it's probably not worth the additional brokerage fees and commissions for you to sell to close. If you take no action to close an out-of-the-money option prior to expiration, it will expire worthless. No further action is required on your part to exit the trade.
In fact, there are a number of strategies where the best-case scenario involves your options expiring worthless -- including multiple premium-selling tactics, such as the short put spread and short call spread. In these strategies, you collect your maximum potential profit upfront, so the ideal outcome is for all of the options involved to remain out-of-the-money through options expiration.
As noted above, when you take up the selling end of an options trade, you'd most frequently like to see the contracts expire worthless. However, if your sold options move into the money by expiration, you are at risk of assignment. This means the buyer on the other end of the transaction may exercise their option for you to either sell (in the case of a call) or buy (in the case of a put) shares of the underlying stock at the strike price of the contract.
If your call option or put option is hedged -- either with cash or shares -- the transaction can be completed with relatively little hassle. However, if you've written naked calls or puts, assignment can be an unwelcome expense. When selling options, always bear in mind the possibility of assignment, and be sure you've planned for such an occurrence.
There's at least one scenario where assignment is your ultimate goal: with the cash-secured put. In this strategy, a trader sells to open put options on a stock he'd like to acquire, aligning the strike with his preferred entry price. Simultaneously, the trader sets aside sufficient capital to buy shares at the strike price of the option. A premium is collected from the sale of the option, which can be used to partially offset the cost of entry on the trade. If the stock falls below the strike price by expiration, the trader welcomes assignment as the chance to buy into a stock he likes on a dip.
It's worth noting that assignment is a possibility whenever your sold options move into the money. However, the risk of assignment increases exponentially as expiration draws closer. If you're short a call or put option that's in-the-money, and you doubt the trade will swing back in your favor by expiration Friday, you may prefer to buy to close your contract(s) in order to avoid an unwanted assignment.
As an option buyer, you have the prerogative to exercise your call option or put option if it moves into the money by expiration. This means you have the right to either buy (for a call) or sell (for a put) shares of the underlying stock.
When you're holding in-the-money calls, you may choose to exercise if you're long-term bullish, and you'd like to acquire shares of the stock at a discount to current market prices. Alternately, if you're short the stock and using call options as a hedge, you can exercise the calls to lock in a maximum repurchase price on the shares.
As a put buyer, you can exercise your option to sell shares of the underlying stock -- which is particularly useful for traders who are long the stock and using protective puts to hedge. By selling shares at the strike price of the put, traders can ensure a minimum exit price on their stake, thereby protecting paper profits or limiting losses on their investment.
Option buyers should be aware that all in-the-money options will be automatically exercised by the close of trading on expiration Friday if no other action is taken to close out the trade. If you'd prefer to unwind the trade by some other means, be sure your broker has the correct instructions.