What Happens When a Call Option Expires?

A call option is a financial contract that provides the buyer the right, but not the obligation, to purchase an underlying asset, such as a stock or exchange-traded fund, at a predetermined price by a specified date. This contract involves two parties: a buyer, known as the holder, and a seller, referred to as the writer.

Key Concepts for Call Option Expiration

The “underlying asset” is the security, like a stock, that the option contract gives the right to buy. The “strike price” is the specific price at which the option holder can purchase the underlying asset. The “expiration date” marks the final day the option contract remains valid.

When a call option is purchased, the buyer pays a “premium” to the seller for this right. This premium consists of two components: intrinsic value and time value. Intrinsic value is the in-the-money portion of an option’s price, while time value reflects the probability of the option becoming profitable before its expiration. As the expiration date approaches, the time value of an option diminishes to zero, a phenomenon known as time decay. At expiration, the option contract either ceases to exist or is exercised or assigned based on its final status.

When a Call Option Expires Out-of-the-Money

A call option is considered “out-of-the-money” (OTM) if the underlying asset’s market price at the expiration date is below the option’s strike price. In this scenario, exercising the option would mean buying the asset at a price higher than its current market value, which is not financially advantageous. Therefore, the option expires worthless.

For the call option holder, the primary outcome is the loss of the entire premium paid when purchasing the option. Since the option has no intrinsic value, there is no incentive to exercise the right to buy, and the contract simply lapses.

Conversely, the call option writer benefits in this situation. The option expires worthless, and the writer retains the full premium received when the option was initially sold. The writer’s obligation to sell the underlying asset at the strike price is extinguished without being invoked.

It is important to note that an “at-the-money” (ATM) call option, where the underlying asset’s price is exactly equal to the strike price at expiration, also expires worthless. Similar to OTM options, there is no intrinsic value to be gained, and exercising the option would not yield a profit. Both OTM and ATM call options result in the buyer losing the premium and the seller retaining it.

When a Call Option Expires In-the-Money

A call option is “in-the-money” (ITM) when the underlying asset’s market price at expiration is above the option’s strike price. This situation makes the option valuable, as the holder can purchase the asset for less than its current market price.

For the call option holder, an ITM option is typically subject to “automatic exercise” by the Options Clearing Corporation (OCC). This occurs if the option is in-the-money by a specified threshold, which is commonly $0.01 or more for equity options. When automatically exercised, the holder’s brokerage account will be credited with shares of the underlying asset at the strike price.

The profit for the holder is generally calculated as the current market price minus the strike price, then subtracting the initial premium paid for the option. Exercising an ITM call option requires the holder to have sufficient funds in their brokerage account to cover the purchase of the shares at the strike price.

If the account lacks the necessary cash, the brokerage firm might, at its discretion, issue a “Do Not Exercise” (DNE) instruction on the holder’s behalf, or the firm may close out the position. Holders can also submit a DNE request to their broker if they do not wish for an ITM option to be automatically exercised, typically by a specific cutoff time on expiration day, often 4:15 PM ET.

For the call option writer, an ITM option results in “assignment,” meaning they are obligated to sell shares of the underlying asset at the strike price to the exercising holder. The Options Clearing Corporation assigns these exercise notices to clearing members, who then assign them to their customers who wrote the options. Shares will be debited from the writer’s brokerage account at the strike price, or cash will be debited in the case of cash-settled options.

The financial outcome for the writer in an assignment scenario involves the premium received when selling the option, offset by the difference between the current market price and the strike price at which they must sell the shares. If the writer does not own the underlying shares (a “naked call”), they would need to purchase them at the higher market price to fulfill the obligation, potentially incurring significant losses beyond the premium collected. Both holders and writers should closely monitor ITM options near expiration due to these automatic processes and potential account implications.