Investment and Financial Markets

When Do American-Style Option Trades Settle?

Master the critical timelines for American-style option trades, detailing when premium exchanges settle and how underlying asset transfers occur upon exercise.

Financial options are derivative contracts that allow participants to manage risk or speculate on the price movements of an underlying asset. Understanding the timing of how these trades settle is important.

What are American-Style Options

American-style options provide the holder with the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, known as the strike price. A call option grants the right to buy, while a put option grants the right to sell. A defining characteristic of American-style options is their flexibility: they can be exercised at any point from the time of purchase up to and including the expiration date. This contrasts with European-style options, which permit exercise only on the expiration date itself.

How Option Contracts Settle

The initial transaction involving an option contract primarily concerns the premium, which is the price paid by the buyer to the seller for the rights conveyed by the option. The settlement of this premium occurs on a “T+1” basis. This means the actual transfer of funds for the option premium takes place on the trade date (T) plus one business day. For example, if an option contract is purchased on a Monday, the premium would typically settle by Tuesday morning. This T+1 settlement specifically applies to the option contract itself, ensuring the swift exchange of the premium and ownership of the derivative. This process is distinct from any subsequent settlement of the underlying asset.

Settlement After Exercise or Assignment

When an American-style option is exercised, it initiates a transaction involving the underlying asset. This resulting trade settles independently according to the standard settlement rules for that asset. For most equity options, the underlying stock transaction settles on a “T+1” basis, meaning the transfer of shares and funds occurs one business day after the exercise. This updated T+1 settlement for stocks came into effect in May 2024, reducing the previous T+2 timeframe.

The exercise of an option by the holder leads to an assignment for the option seller. Assignment is the obligation for the seller to fulfill the contract terms, such as delivering shares for a call option or purchasing shares for a put option. This assigned obligation also results in a T+1 settlement for the underlying asset. This means the assigned party must deliver or receive the underlying shares and associated funds by the next business day. The flexibility of American-style options allows holders to trigger this T+1 settlement of the underlying asset at their discretion any time before the option expires.

Important Timelines and Expiration

Most equity options have a standard expiration day, which typically falls on the third Friday of the expiration month. If this third Friday happens to be a market holiday, the expiration date usually shifts to the preceding Thursday.

While American-style options can be exercised at any time before expiration, there are practical cut-off times for exercising on the expiration day itself. The Financial Industry Regulatory Authority (FINRA) indicates that option holders generally have until 5:30 PM Eastern Time (ET) on the expiration day to submit a final exercise decision. However, many brokerage firms may establish earlier internal deadlines for accepting exercise instructions from their customers.

Options that are “in-the-money” (ITM) at expiration are typically subject to automatic exercise by the Options Clearing Corporation (OCC). This occurs if the option’s intrinsic value is $0.01 or more. If an option holder does not wish for an ITM option to be automatically exercised, they must submit a “Contrary Exercise Advice” to their broker by the specified deadline. This automatic exercise, or manual exercise, then triggers the T+1 settlement process for the underlying asset.

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