Exercise: Definition and How It Works (Options) What is exercise? To exercise an option means to put into effect the contract right to buy or sell the underlying security at the contract’s specified strike price. An option holder has the right—but not the obligation—to buy (call) or sell (put) the underlying asset on or before a specified date. How exercising works
* You inform your broker that you want to exercise the option.
* The broker files an exercise notice, which is processed through the Options Clearing Corporation (OCC).
* The OCC assigns a counterparty (the option writer), who is obligated to fulfill the contract terms.
* Depending on the contract, exercise results in delivery of the underlying shares (physical settlement) or a cash settlement.
Call vs. put
* Call option: exercising lets the holder buy the underlying security at the strike price.
* Put option: exercising lets the holder sell the underlying security at the strike price.
Timing rules
* American-style options can be exercised any time up to expiration.
* European-style options can be exercised only at expiration.
Common practice Most traded options are not exercised. Instead, holders typically:
- Sell the option to close the position, or
- Let the option expire worthless if it has no value.
Exercising is often less common because closing the position can be simpler and avoid some fees or tax consequences. Things to consider before exercising
* Type of option (American vs. European)
* Vesting restrictions (common with employee stock options)
* Transaction costs and commissions — ensure exercise makes economic sense
* Tax implications — exercising may trigger taxable events depending on the option type and your situation
* Alternative strategies (selling the option, closing with offsetting trades)
Key takeaways
* Exercising converts the contractual right into the actual buy or sell of the underlying security at the strike price.
* To exercise, notify your broker; the OCC processes the exercise and assigns the writer.
* Consider timing rules, costs, vesting, and taxes before exercising—often selling the option or letting it expire is preferable.
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