Most options are closed before expiration, never used. The ones still open at the end, and the ones someone chooses to use early, go through exercise and assignment. Those mechanics decide what is in your account the next morning: shares, cash, or a short stock position you did not plan for.
Exercise and assignment
Using the right is called exercise. A call owner who exercises buys 100 shares at the strike; a put owner sells 100 shares at the strike. Every exercise is matched to someone who sold that contract, and being picked to take the other side is called assignment. Exercise and assignment run through the clearing house that stands between every buyer and seller, the Options Clearing Corporation. It hands each exercise at random to a broker whose customers are short that contract, and the broker picks one of them at random or by another fair method.
| Your position | What happens | You end up with |
|---|---|---|
| Long call | You exercise | 100 shares bought at the strike |
| Short call | You are assigned | 100 shares sold at the strike; short 100 shares if you did not own them |
| Long put | You exercise | 100 shares sold at the strike; short 100 shares if you did not own them |
| Short put | You are assigned | 100 shares bought at the strike |
American and European style
An American-style option can be exercised on any business day up to expiration; options on US stocks and ETFs, SPY included, are American. A European-style option can be exercised only at expiration; most broad index options, SPX among them, are European. For a seller, the practical side of the American versus European difference is simple: an American option can be assigned early.
When exercising early actually pays was worked out in Module 10: almost never for a call except just before a dividend, and sometimes for a deep in-the-money put. An owner who exercises early throws away the time value left, so an early assignment is a sign the option had almost none.
Time value of a $100 call against the stock price with 60, 20 and 3 days left. Deep in the money with a few days left it is worth pennies, which is when an owner may as well exercise. Raise volatility and every line lifts: the more time value left, the less likely an early assignment.
Deep in the money with a few days left, time value is worth pennies, and that is where early assignment notices come from. They arrive overnight: you find the shares, or the short shares, in your account the next morning. If the short leg of a spread is assigned, the long leg still limits your loss.
Automatic exercise at expiration
A stock or ETF option that finishes in the money by one cent or more is exercised on its own unless the owner tells the broker not to. This is automatic exercise, also called exercise by exception; options out of the money simply expire. A long SPY call that finishes $2 in the money turns into 100 shares, which on a $500 fund is $50,000 of stock bought with money you may not have. If you do not want the shares, close the option yourself before the bell.
Physical and cash settlement
How an exercise is paid for is called settlement. Stock and ETF options are physically settled: shares change hands at the strike. Index options such as SPX are cash settled: an in-the-money option pays the difference between the settlement value and the strike, times 100. Module 12 introduced SPX; what matters here is when its settlement value is set.
AM and PM settlement
Stock and ETF options settle on the closing price on expiration day, called PM settlement. The standard monthly SPX options, which expire on the third Friday, are AM settled: they stop trading at Thursday's close, and their settlement value comes from the opening prices of the index's stocks on Friday morning. That number can land well away from Thursday's close, and in between you hold a position you cannot trade. The SPX weeklies and dailies, under the symbol SPXW, settle on the close.
Pin risk
The awkward case is a stock that closes right at the strike of an option you are short. This is pin risk. Owners decide after the close. They have until an evening cutoff (5:30 pm Eastern at the exchanges, earlier at many brokers), they can decline to exercise an option a cent in the money or exercise one a few cents out of it, and news after the bell can change their minds. You find out on the next business day, with a night or a weekend in between.
The chance a $100 call finishes in the money, for prices within 3% of the strike, at 20% volatility. As expiration nears the curve turns into a cliff, but hover at $100 and every line reads 50%: a small move after you stop watching decides whether you are assigned.
With hours to go, the chance of finishing in the money swings from near zero to near one within a dollar of the strike, but at the strike itself it is still a coin flip. The cure is cheap: close short options near the money before the close on expiration day. Cash-settled index options deliver no shares, so pin risk in this form is a stock and ETF problem.
The maths: exercising versus selling, and what a pin can cost
Exercising a call pays the strike K for shares worth S, so it captures the intrinsic value S − K per share. Selling the call captures its mid m, which is intrinsic value plus time value: m = (S − K) + TV. Exercise early and you give up TV × 100 per contract, which for a call only makes sense when a bigger dividend is about to be paid, the condition from Module 10.
Worked example. The stock is $500 and the $480 call's mid is $21.30. Intrinsic value is 500 − 480 = $20.00, so time value is $1.30. Exercising gets $2,000 of value per contract; selling gets $2,130. That $130 is why an early assignment on this call is unlikely.
A pin in numbers. Short 10 calls at $500 with the stock closing at $500.02: if every contract is assigned you are short 1,000 shares, which lose 1,000 × gap dollars if the stock opens higher, $5,000 on a $5 gap.
Your turn
Open SPY on the Options Chain at the monthly expiration. Take the in-the-money call about 5% below the price, work out its intrinsic value and its time value, then switch to the nearest expiration and find the strike closest to the price right now.