What Happens When a Call Option Expires?

When an investor buys a call option, they acquire a financial contract granting the right, but not the obligation, to purchase an underlying asset, such as shares of stock, at a predetermined strike price. This right exists for a specific duration, concluding on a set expiration date. The expiration date marks the final moment this contract is valid, after which it ceases to exist.

Understanding Option Status at Expiration

A call option’s status at expiration is determined by comparing the underlying asset’s market price to the option’s strike price. This comparison categorizes the option into one of three states: in-the-money, out-of-the-money, or at-the-money. This status is determined at a specific time on the expiration date, based on the closing price of the underlying asset on its primary exchange.

A call option is “in-the-money” (ITM) when the underlying asset’s market price is higher than the option’s strike price. For example, if a call option has a strike price of $50 and the stock closes at $50.01 or higher on expiration day, it is ITM. This makes the option valuable, as the holder can acquire shares below the current market value. ITM call options are generally exercised, allowing the holder to purchase the underlying shares at the lower strike price.

Conversely, a call option is “out-of-the-money” (OTM) if the underlying asset’s market price is below the option’s strike price at expiration. Exercising an OTM option would mean buying shares at a price higher than the open market. OTM call options expire worthless, and the option holder loses the entire premium paid for the contract. No further action is required from the holder.

An option is “at-the-money” (ATM) when the underlying asset’s market price is exactly equal to or very near the option’s strike price. ATM options expire worthless, as there is no practical financial incentive to exercise them due to factors like transaction costs or the Options Clearing Corporation’s (OCC) automatic exercise threshold. The threshold for automatic exercise is typically set to options that are at least $0.01 in-the-money.

The Automatic Exercise and Assignment Process

The Options Clearing Corporation (OCC) standardizes and facilitates the exercise and assignment of options contracts in the U.S. market. The OCC guarantees options contracts, ensuring obligations are met when an option is exercised, providing security and efficiency.

For call option holders, the process at expiration is automated if their option is in-the-money. The OCC’s automatic exercise rule, “exercise by exception,” stipulates that any expiring equity or exchange-traded fund (ETF) option closing at least $0.01 in-the-money will be automatically exercised. This protects holders from losing potential gains if they forget to manually exercise. Holders can, however, submit a “do not exercise” (DNE) instruction to their brokerage if they wish to prevent the automatic exercise of an ITM option, typically by a specified time on expiration day.

If an option is OTM or ATM, it will not be automatically exercised by the OCC and expires worthless. Holders do not need to take any action. Brokerage firms may have specific cutoff times for exercise instructions, which can be earlier than the OCC’s deadlines; investors should be aware of their firm’s policies.

For the call option writer, an ITM option’s expiration means they face an “assignment” of their obligation. When a call option buyer exercises, the OCC randomly allocates the exercise notice to brokerage firms with clients short that option contract. These brokerage firms then use their own approved methods, often a random selection or a first-in, first-out (FIFO) basis, to assign the obligation to their clients who wrote the options. This assignment obligates the writer to sell the underlying shares at the strike price.

Most equity options, including call options on stocks, are settled through physical delivery. Upon exercise and assignment, the underlying shares are transferred from the writer’s account to the holder’s account. In contrast, certain index options and commodity options are typically cash-settled, where a cash payment representing the difference between the strike price and the underlying asset’s value is exchanged, rather than the physical asset itself. The choice between physical delivery and cash settlement depends on the underlying asset and contract specifications.

Outcomes for Call Option Holders and Writers

A call option’s expiration leads to distinct financial outcomes for both the holder (buyer) and the writer (seller), depending on the option’s status. If a call option holder’s option expires in-the-money and is exercised, they acquire the underlying shares at the strike price. The net financial outcome is calculated by subtracting the premium paid from the difference between the market price and the strike price. For instance, if a call with a $50 strike was bought for a $2 premium and the stock closes at $55, the holder buys shares at $50 that are worth $55, resulting in a gross profit of $5 per share. After the $2 premium, the net profit is $3 per share. If the option expires out-of-the-money or at-the-money, it expires worthless, and the holder loses the entire premium paid. This is the maximum potential loss for the option buyer. For tax purposes, an expired, unexercised option results in a capital loss equal to the premium paid, which is typically considered short-term if held for less than a year.

If a call option writer’s option expires in-the-money and they are assigned, they must sell the underlying shares at the strike price to the option holder. The financial outcome for the writer is the premium received, offset by any loss from selling shares below market value. If a writer sold a call with a $50 strike for a $2 premium and the stock closes at $55, they must sell shares for $50 that are worth $55, incurring a gross loss of $5 per share. Offset by the $2 premium, the net loss is $3 per share. If the option expires out-of-the-money or at-the-money, it expires worthless, and the writer retains the full premium received. This premium is the maximum potential profit for the option writer. From a tax perspective, the premium received from an expired written option is generally treated as a short-term capital gain, regardless of the holding period.