Options Trading Options Exercise and Assignment 2 — Questions and Answers
Question 1: Which of the following is the most common reason a call option holder might exercise early?
- To capture an upcoming dividend on the underlying stock (Correct answer)
- To avoid time value decay on the premium paid
- To lock in remaining time value before expiration
- To reduce the total cost basis of the position
Correct answer: To capture an upcoming dividend on the underlying stock
Early exercise of a call option can be rational when an upcoming dividend is large enough to exceed the call's remaining time value, making it economically beneficial to exercise and collect the dividend.
Question 2: What does 'pin risk' refer to in options trading near expiration?
- The risk that the underlying stock gaps far away from the strike
- Uncertainty when a stock closes exactly at or near the strike price at expiration (Correct answer)
- The risk of being assigned on multiple contracts simultaneously
- A type of illiquidity that prevents closing an options position
Correct answer: Uncertainty when a stock closes exactly at or near the strike price at expiration
Pin risk occurs when the underlying stock closes very close to the strike price at expiration, creating uncertainty about whether enough in-the-money options will be exercised to trigger assignment.
Question 3: Which of the following statements about assignment is most accurate?
- Only in-the-money options are typically exercised and result in assignment (Correct answer)
- Assignments can occur on any option regardless of moneyness
- Option sellers can always predict exactly when they will be assigned
- Assignment only occurs at expiration, never before
Correct answer: Only in-the-money options are typically exercised and result in assignment
Rational option holders only exercise options that are in-the-money, since exercising an out-of-the-money option would result in an immediate loss.
Question 4: What is the OCC's typical deadline for option holders to submit exercise notices on expiration day?
- 9:30 AM ET when the market opens
- 4:00 PM ET at the regular market close
- 5:30 PM ET after the market closes (Correct answer)
- Midnight at the end of expiration day
Correct answer: 5:30 PM ET after the market closes
The OCC deadline for submitting exercise notices on expiration day is typically 5:30 PM ET, though individual brokers often have earlier internal cutoffs.
Question 5: Why is the ex-dividend date important to options traders managing short call positions?
- It is the date after which buyers no longer receive the declared dividend, making early call exercise more likely (Correct answer)
- It is the date when all short options are automatically assigned
- It is the date when implied volatility typically spikes for the underlying
- It is the settlement date for all options that were in-the-money
Correct answer: It is the date after which buyers no longer receive the declared dividend, making early call exercise more likely
On and just before the ex-dividend date, call holders may exercise early to capture the dividend, increasing assignment risk for short call sellers if the dividend exceeds remaining time value.
Question 6: If you are short a put and it is assigned, what position will you hold in your account?
- Short 100 shares of the underlying stock
- A long call option at the same strike price
- Long 100 shares of the underlying at the strike price (Correct answer)
- No position — the assignment cancels the put trade
Correct answer: Long 100 shares of the underlying at the strike price
When a short put is assigned, you are required to buy 100 shares at the strike price, resulting in a long stock position at that cost basis.
Question 7: Which of the following best describes the OCC's 'automatic exercise' rule at expiration?
- The OCC automatically exercises all options that are in-the-money by at least $0.01 (Correct answer)
- All options are automatically exercised regardless of whether they are in or out of the money
- Out-of-the-money options are automatically rolled to the next monthly cycle
- Brokers automatically close all open options positions one day before expiration
Correct answer: The OCC automatically exercises all options that are in-the-money by at least $0.01
The OCC's automatic exercise rule exercises all equity options that are in-the-money by $0.01 or more at expiration, unless the holder submits a 'do not exercise' notice.
Options Trading Options Exercise and Assignment 2
Which of the following is the most common reason a call option holder might exercise early?