Transactions Unique to Options - dummies

By Joe Duarte

Because option contracts are created as needed, there is a unique way to enter option orders. You identify whether you are creating a new position or closing an existing position by including the following with your order:

  • Buy to Open

  • Sell to Open

  • Sell to Close

  • Buy to Close

In addition, exercising contract rights create a buy or sell transaction in the underlying stock that goes through the OCC.

The exercise process

You exercise your option contract by submitting exercise instructions to your brokerage by its cutoff time. Check with your brokerage for this information. It usually takes one day for the option exercise and associated stock transaction to appear in your account.

When you exercise a put and do not own the underlying stock in your account, you are creating a short stock position. Be sure you understand all the risks and rewards associated with submitting exercise instructions.

The assignment process

When you sell an option, you are creating a short position on a stock option contract. Thus you are at risk of assignment from the time you create the position through expiration of the contract. The only way you can alleviate yourself of the obligation is to exit the position by entering a Buy to Close order for the option. Basically, when assigned you are on the receiving end of the transactional flow:

  • When holding a short put, the assigned option is removed from your account, and a Buy transaction occurs for the underlying stock.

  • When holding a short call, the assigned option is removed from your account, and a Sell transaction occurs for the underlying stock.

Contact your broker to find out the method the firm uses to assign short options. Almost all use a random selection process.