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I hold a profitable in-the-money call that I want to hold until expiration in order to lock in the highest return. I am unsure exactly what the broker's process is when an option expires with value.

I assume that an exercise is triggered which would mean my account would acquire 100 shares of the underlying stock per contract. At what price are the stocks acquired? Is it simply the strike price or is it the market rate? And are these shares then instantly sold with that value added to my account balance?

Edit: For example, say I own an XYZ $100 call which I bought when XYZ was $75. The market price is liable to fluctuate due to the volume of trades but suppose it's roughly $125 at expiration. At expiration, would 100 shares be deposited in my account at a cost to me of $100 per share, and would they automatically be sold at some rate on the market by my broker?

Please feel free to challenge any assumptions I may have made in my post, I'm a complete beginner so maybe I have made some mistakes!

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I assume that an exercise is triggered, which would mean my account would acquire 100 underlying stocks per contract

Correct - you would get 100 shares per contract and pay 100 times the strike price of your option.

Are these then instantly sold and the value of them added to my account balance?

No - if you want to sell the stock you need to make that a separate transaction. You do have some market risk after expiry, so if you want to lock in the profits then either put in a stop order with a high threshold (if your broker supports a stop loss order on a stock you don't own yet), or sell the option right before expiry.

I question why holding the option to expiry "locks in the highest level of returns". You could sell the option a day or two before expiry while it still has some time value above the paper gain and increase your return. Also, with a deep in-the-money option you basically own the stock, since any change in the stock's price change's the options value almost as much (in "greeks" terms, your "delta" is close to 1). So even before expiry you have a risk of losing value if the stock drops.

And at what price are the stocks acquired, is it simply the strike price, or is it the market rate?

The option gives you the right to buy at the strike price, so that's your cost basis (plus the premium you paid).

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  • Thanks for the answer. The reason I thought the value of the example option was highest was due to the graphs that my broker supplies. They seem to indicate that, given a position that's very deep in-the-money, the closer to expiry then the more certain it is that it will expire with value, e.g. i.stack.imgur.com/QMjDf.png seems to indicate that when the option expires (the dotted line), there is more certainty of the option having value on expiration than it does today (solid line). Perhaps the issue is me understanding this graph poorly?
    – Bryn
    Jul 10, 2020 at 13:17
  • @Bryn That PL graph doesn't look right for a call potion - as the price of the underlying stock goes up, the value of the option goes up. So I'm not sure how to interpret that either. One thing you could do is look at how much you could sell the option for today - it's almost certainly worth more that the paper gain (stock price-strike).
    – D Stanley
    Jul 10, 2020 at 13:46
  • Also look at en.wikipedia.org/wiki/Option_time_value for more info on time value.
    – D Stanley
    Jul 10, 2020 at 13:47
  • @Bryn - The PnL graph in your link is incorrect.
    – Bob Baerker
    Jul 10, 2020 at 13:51
  • @D Stanley - When call options are exercised, the premium is included as part of the cost basis of a stock.
    – Bob Baerker
    Jul 10, 2020 at 13:53
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Holding your long call until expiration does not "lock in the highest level of returns." The value of your call is dependent on the price of the stock. If you want to 'lock in' the current gain, you need to adjust your position but that is another story.

In the US, all options that are one cent ITM at expiration are automatically assigned. Long option owners can designate that this not occur but that is not applicable to your circumstances. Per your example, you will buy the stock for $100 and your cost basis will be $100 plus the cost of the call. You will have to sell the stock to realize the gain.

If you do not want to own the stock, simply sell the call at or before expiration, realizing your gain.

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