The terms under which the buyer may exercise their right are deter-
mined by the ‘style’ of the option. As previously noted there are four
styles of options:
1. American – exercisable on any business day
2. European – exercisable on expiry
3. Bermudan – exercisable at preset timings
4. Asian or Average – exercised against an average underlying price.
In the traded option markets, European and American options
are listed. The process for exercising an option is set out in the rules
and regulations of the clearing house and in the contract spec-
ification published by the exchange on which the option is traded.
The clearing house establishes the method and timings for the exer-
cise of options and the clearing members must adhere to these
The decision on whether to exercise an option depends on whether
the option has any intrinsic value. Intrinsic value occurs when the
strike price viewed against the current underlying asset price has a
value. For example, if the underlying price is 100 and the strike price
of a call option is 80 then there is an intrinsic value of 20 because
the holder of the option can exercise the right to take delivery of the
underlying at a cost of 80 when it is priced at 100 in the market. The
option is known as an in-the-money option. However, the put option
with a strike price of 80 and an underlying price of 100 is an out-of-
the-money option because it has no intrinsic value as no one would
want to exercise the option to sell the underlying at 80 when they
could sell it in the market at 100.
• In-the-money A call option where the exercise price is below the
underlying asset price or a put option where the exercise price is
above the underlying asset price. These options are deemed to
have intrinsic value of the in-the-money difference between the
exercise price and the underlying asset price.
• At-the-money An option whose exercise price is equal, or closest,
to the current market price of the underlying asset. This option
has little or no intrinsic value as there is no in-the-money differ-
ence between the exercise price and the underlying asset price.
• Out-of-the-money A call option whose exercise price is above the
current underlying asset price or a put option whose exercise
price is below the current underlying asset price. This option has
no intrinsic value.
92 Clearing and settlement of derivatives