Exercising Stock Options
In order to understand how to exercise one’s stock options it would be best to have a review of the important stock option concepts. A stock option is a contract wherein the holder has a right, but not necessarily the obligation, to buy (or sell) 100 shares of stocks for a specified price in a given period. The holder must pay the premium, which is the price to be paid to be able to own stock options, which is separate and distinct from the stock price itself. The stock that can be bought (or sold) at the option of the holder is called the underlying asset. The specified price in which the stocks can be bought is called the strike price or option price. There are three types of stock options: American Stock Options, European Stock Options and Capped Stock Options. All of these types have nothing to do with nationality or geography. In an American Stock Option, the holder has the choice of exercising the option either on or before the expiration period whereas in the European Stock Option the holder can only exercise the stock within a given period before the expiration. The Capped Stock Options, like the European style, can only be exercised within a given period before the expiration except if the option arrives at the cap value. If it does, the stock option is automatically exercised. The holder or writer of the option can choose to close his position in the option by making a closing or offsetting transaction. The holder can make a closing transaction which means the holder makes an identical offsetting sale of an option or the writer makes an identical offsetting purchase of an option. By making a closing transaction the holder or writer of the option divests himself of his position as holder or writer.
Let us assume that the holder has already paid the premium and has chosen to exercise the stock option. How does the holder exercise his stock option? The holder must inform his broker that he wants to exercise his option so that the broker can submit an exercise notice to the Options Clearing Corporation (OCC). The holder must inform his broker of his intention to exercise the option before that day’s cut-off time. Different brokerage firms have different cut-off times and different kinds of options also have different cut-off times. Upon acceptance of the exercise notice the OCC will then assign the exercise notice to one of its Clearing Members with a short position in that particular stock option. A person has a short position if he sells more than he buys of the same kind of stock option. The Clearing Member will then assign it to one of its customers that also have a short position. The assigned Clearing Member is obligated to sell (for calls) or to buy (for puts) the underlying asset at the specified strike price. The OCC then makes an arrangement with a stock clearing corporation to deliver the shares of stock (in case of calls) or the settlement amount (in case of puts).