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Equity and Index Options Explained by W. A. Beagles

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3

Exercise and Assignment

The point has already been made that derivatives, whether options or futures, are contracts. When we trade a future, we are trading a futures contract. When we trade an option, we are trading an options contract. These contracts are transferable, they are tradable between market participants. We can buy an option from one person and sell it to a different person. We do this via the exchange and the related clearing house, such as LIFFE and LCH Clearnet. Trading is anonymous. We don't know who we have traded with and nor do we care; it is irrelevant. When we buy 5 Sept BP £6.00 puts and then sell 3 of them, we don't have two positions. We are not long of 5 puts and short of 3 puts. Rather, we have a net position of long 2 puts. There may also be a profit or loss, depending upon the prices at which we traded, but our position is simply the net result of the two trades. Furthermore, we can trade in and out of options positions as and when we want, at any time while the market is open until expiry. Options positions do not have to be held until expiry. We may buy some options this morning and sell them an hour later (“intra-day” trading). Or we may buy some options today and sell them tomorrow or next week or next month, any time until expiry. The following section considers what happens if we hold an option position all the way to expiry; the mechanics and consequences of exercise and assignment.

The owner of an option may exercise their right to buy (in ...

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