When trading options, you are essentially betting on the future direction of a particular asset. If you think the price of an underlying security will go up, you will buy a call option. If you anticipate that the price will decrease, you will buy a put option.
Options contracts give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specific date. When an options contract expires, it is said to be “settled.”
It is when the underlying asset is exchanged between the buyer and seller. Let’s say you own a call option on ABC stock with a strike price of $50, and the stock is trading at $60 on the expiration date. You would exercise your option, and the seller would be obligated to give you 100 shares of ABC stock at $50 per share. You would then sell those shares on the open market for $60 per share, resulting in a profit of $10 per share.
With this method, no exchange of underlying assets takes place. Instead, the buyer and seller agree to settle the option contract for cash. It is most often used with index options and options on futures contracts. So, if you have a put option on the S&P 500 Index with a strike price of 2,100 and the index settles at 2,050 on the expiration date, you would be paid $50 per contract ($5,000 per 100-point contract)
While most options are settled in one of these two ways, there are other methods of settling an options contract. For example, some companies will allow employees to settle their stock options by exchanging them for company stock. It is known as a “stock swap.”
It’s imperative to remember that not all options contracts can be settled physically. For example, if you have a call option on a particular stock but don’t own the underlying shares, you won’t be able to exercise the option and receive the shares. In this case, you would have to settle for cash.
The method of settlement is generally specified in the options contract. If you’re not sure how your option will be settled, you can always check with your broker or the Options Clearing Corporation (OCC), which is the organization that clears all trades for listed options in the United States.
When you exercise an option, the option holder gives up the right to buy or sell the underlying asset and receives either cash or shares, depending on the option type and how it is settled. If a call option is exercised, the holder buys shares of the underlying asset at the strike price. If a put option is exercised, the holder sells shares of the underlying asset at the strike price.
Two primary exchanges
When it comes to listed options, there are two primary exchanges where these contracts are traded: the Chicago Board Options Exchange (CBOE) and the American Stock Exchange (AMEX). The type of settlement used for listed options will be determined by the exchange in which they are traded.
The Chicago Board Options Exchange (CBOE)
The CBOE uses physical settlements for all of its options contracts, regardless of what underlying asset they are based on. If you buy or sell a CBOE option, you will need to be prepared to either receive or deliver the underlying asset on the expiration date.
The American Stock Exchange (AMEX)
The AMEX, on the other hand, uses cash settlements for all of its options contracts. If you buy or sell an AMEX option, you will receive or pay cash on the expiration date, based on the predetermined price of the underlying asset.
If you are thinking about trading options, it’s essential to understand how they are settled. The settlement method will determine what happens when the option expires and whether or not you receive the underlying asset. Be sure to check with your broker or the OCC to determine how your options contract will be settled. You can read more here.