How do options settle

When you are a buyer of a call option , you have all three ways of settling option contracts- squaring off, physical settlement and allowing the contract to expire valuelessly. If you are a seller of a call option then you have only one option of squaring off the trade.

The other two options of physical settlement and allowing a contract to expire worthlessly is not available to you. To settle the Call option trade as a seller, you need to buy the same number of lots of the Call option of same underlying and same expiration that you have sold initially. If you are a buyer of a Put Option then all the three above mentioned options- squaring off, physical settlement and allowing the contract to expire worthlessly is available to you.

For a seller of a Put Option , squaring off is the only option available. You can buy back the exact number of lots of the Put option of same underlying and expiration that you sold.

Open Instant Account. Enquire Now. Request Call Back. There are two methods by which options can be settled when exercised; physical settlement and cash settlement. All contracts will state which form of settlement applies. Below we explain both of these settlement types and how they work. Physical settlement is the most commonly used form of settlement.

Physically settled options are those that involve the actual delivery of the underlying security they are based on. The holder of physically settled call options would therefore buy the underlying security if they were exercised, whereas the holder of physically settled put options would sell the underlying security.

Physically settled options tend to be American style, and most stock options are physically settled. It isn't always immediately obviously when looking at options as they are listed whether they are physically settled or cash settled, so if this aspect is important to you it's well worth checking to be absolutely sure.

In practice whether an option is physically settled or cash settled isn't particularly relevant that often. The track simply takes a small cut for providing the facilities.

So trading options, like betting at the horse track, is a zero-sum game. The option buyer's gain is the option seller's loss and vice versa. One important difference between stocks and options is that stocks give you a small piece of ownership in a company, while options are just contracts that give you the right to buy or sell the stock at a specific price by a specific date. It's important to remember that there are always two sides to every option transaction: a buyer and a seller.

In other words, for every option purchased, there's always someone else selling it. The two types of options are calls and puts. When you buy a call option , you have the right, but not the obligation, to purchase a stock at a set price, called the strike price , any time before the option expires.

When you buy a put option , you have the right, but not the obligation, to sell a stock at the strike price any time before the expiration date.

When individuals sell options, they effectively create a security that didn't exist before. This is known as writing an option, and it explains one of the main sources of options since neither the associated company nor the options exchange issues the options. When you write a call, you may be obligated to sell shares at the strike price any time before the expiration date.

When you write a put, you may be obligated to buy shares at the strike price any time before expiration. There are also two basic styles of options: American and European. An American-style option can be exercised at any time between the date of purchase and the expiration date. A European-style option can only be exercised on the expiration date.

Most exchange-traded options are American style, and all stock options are American style. Many index options are European style. The price of an option is called the premium. The buyer of an option can't lose more than the initial premium paid for the contract, no matter what happens to the underlying security.

So the risk to the buyer is never more than the amount paid for the option. The profit potential, on the other hand, is theoretically unlimited. In return for the premium received from the buyer, the seller of an option assumes the risk of having to deliver if a call option or taking delivery if a put option of the shares of the stock. Unless that option is covered by another option or a position in the underlying stock, the seller's loss can be open-ended, meaning the seller can lose much more than the original premium received.

Please note that options are not available at just any price. Also, only strike prices within a reasonable range around the current stock price are generally traded. Far in- or out-of-the-money options might not be available. When the strike price of a call option is above the current price of the stock, the call is not profitable or out-of-the-money.

In other words, an investor is not going to buy a stock at a higher price the strike than the current market price of the stock. When the call option strike price is below the stock's price, it's considered in-the-money since the investor can buy the stock for a lower price than in the current market.

Put options are the exact opposite. They're considered out-of-the-money when the strike price is below the stock price since an investor wouldn't sell the stock at a lower price the strike than in the market. Put options are in the money when the strike price is above the stock price since investors can sell the stock at a higher strike price than the market price of the stock.

All stock options expire on a certain date, called the expiration date. For normal listed options, this can be up to nine months from the date the options are first listed for trading. Longer-term option contracts, called long-term equity anticipation securities LEAPS , are also available on many stocks.