What Happens If a Call Expires In the Money?

When engaging with financial markets, individuals may encounter call options, which grant the holder the right, but not the obligation, to purchase an underlying asset at a predetermined price on or before a specified expiration date. Understanding what happens when a call option expires profitably is important. This article will explain the processes and financial outcomes that occur when a call option expires “in the money.”

Understanding In The Money for Call Options

For a call option, “in the money” describes a situation where the price of the underlying asset has risen above the option’s strike price. The strike price is the fixed price at which the option holder can buy the underlying asset. When the market price exceeds this strike price, the call option holds intrinsic value, making it profitable to exercise.

To determine the intrinsic value of an in-the-money call option, calculate the difference between the current market price of the underlying asset and the option’s strike price. For instance, if a call option has a strike price of $50, and the underlying stock is trading at $55, the option has an intrinsic value of $5 per share. This $5 represents the immediate profit available per share if the option were exercised. Intrinsic value is the minimum amount the option is worth, reflecting the direct benefit of buying the asset below its current market value. The greater the difference between the asset’s price and the strike price, the more “in the money” the option is.

The Automatic Exercise Process

When a call option you own expires “in the money,” automatic exercise typically takes place. This process is managed by the Options Clearing Corporation (OCC), which acts as the guarantor for all listed option contracts in the United States. The OCC generally exercises any option that is in the money by a certain threshold at expiration. This automatic exercise mechanism protects option holders from inadvertently losing the value of their in-the-money options due to oversight.

Correspondingly, on the other side of the contract, a process called “assignment” occurs. The OCC assigns the obligation to sell the underlying shares to a short option holder. This assigned seller is then obligated to deliver the shares to the exercising call option holder at the strike price, fulfilling the terms of the option contract.

Receiving Shares or Cash Settlement

Following the automatic exercise of an in-the-money call option, the immediate outcome in the option holder’s brokerage account depends on the type of underlying asset. For call options on individual stocks or exchange-traded funds (ETFs), the holder will receive shares of the underlying security. For each option contract, representing 100 shares, the holder will have 100 shares of the stock deposited into their account, with their account debited for the total cost at the strike price.

Option holders must have sufficient cash in their brokerage account to cover this cost. If the account lacks the necessary funds, the brokerage firm may issue a margin call, requiring the investor to deposit additional capital. Should the investor fail to meet a margin call, the brokerage may forcibly sell some or all of the newly acquired shares, or other securities in the account, to cover the deficit, potentially incurring additional fees or unfavorable market prices.

In contrast, certain types of call options, such as those on broad market indexes or some commodity contracts, are cash-settled rather than physically delivered. For these options, instead of receiving shares, the holder’s account is credited with the intrinsic value of the option in cash. This cash amount is calculated as the difference between the underlying index’s closing value and the option’s strike price, multiplied by the contract multiplier. Cash settlement typically occurs within one business day of expiration, providing a direct monetary payout without the need to manage physical assets or potential margin requirements.

Financial Outcomes at Expiration

The ultimate financial outcome for an option holder whose call option expires in the money involves calculating the net profit or loss, considering all transaction costs. This calculation begins by taking the value received from the exercise, whether it’s the market value of the shares acquired or the cash settlement amount, and subtracting the total cost of acquiring those shares at the strike price. From this gross profit, the premium initially paid to purchase the call option must be subtracted.

Investors must also account for any brokerage commissions and fees associated with the exercise or assignment process. While many brokers now offer commission-free trading for options, some may still charge a small exercise or assignment fee. These fees, though small, can impact the final profitability, especially for a large number of contracts or options with minimal intrinsic value.

The final state of the brokerage account will reflect these transactions: either an increased shareholding and a reduced cash balance, or a direct increase in the cash balance for cash-settled options. The net profit or loss is the overall change in the account’s value attributable to the option trade, after all premiums paid and fees incurred have been deducted from the value realized at expiration.