Do options contracts give you cash or the underlying?

Question

Whenever I read about options valuation, it's phrased in terms of payoff diagrams. For European options, the value at expiry is the difference between the strike and the market price of the underlying if I'm in the money.

However, the usual definition of an options contract is not a cash bet conditional on the market price of the underlying, but rather an offer to exchange cash for the underlying asset (or vice versa).

When I buy a call option in practice, is it common to receive the underlying upon exercise and then be required to sell it on the market to realise a profit? Or will the counterparty ever just hand over cash if I'm in the money?

Similarly, does a put option typically give me a literal right to sell the asset, or is it just a cash bet with the payoff conditional on the asset price?

What might influence the particular choice of logistics here?

Answer 1

US centric answer:

The intrinsic value of all ITM options at expiration is the difference between the strike price and the market price of the underlying.

European style index options are cash settled.

American style options are settled with the underlying if they are exercised/assigned:

If you exercise a long call, you buy the underlying at the call's strike price. It's usually more practical to sell-to-close the call, especially if it has any remaining time premium. The exception would be a deep ITM option whose bid is less than the intrinsic value. In that case, do a Discount Arbitrage in order to avoid the haircut.

It's the same for a put except that you have the right to sell the underlying at the strike price.

Answer 2

At least in the US, when options are exercised, you really buy (or sell) the underlying.

To avoid this, the common practice is to sell the option on the last day, which gives you about the difference between strike and underlying price.

Note that an exercised option could get you into overdrawn accounts, shorted securities, or margin calls, and worst case if you don’t have the margin, your broker decides to not exercise it (meaning the value is lost). Make sure you know what you do when you wait for expiry (or pay dearly for the lesson).

Answer 3

1. They do "literally, honest to God" give you the right

2. In the overwhelming majority of trades ever made, they are just traded as-is. I would imagine that many if not most casual traders who buy and sell options don't even fully know or understand "what they are" (ie, that they relate to point 1).

3. You know when you "invent something" that actually exists already? In para 3 you've "invented" "cash settled". Indeed, some options (same deal w/ futures) are "cash settled" but (as I understand it) if you're thinking options on plain old USA major exchange stocks, no, those are honest-to-God settled .. someone has to dig up the actual item at any cost. (Indeed there are a number of fascinating Qs on this site about what happens in extreme/theoretical cases where that is just not possible.)

(Recall too that a given individual contract may / will be traded many times, again, there are much more trades that options (just as there are, obviously, tremendously more trades of apple shares than there are apple shares - they go back and fore.)

By the way, you can find endless articles about exactly the issue you ask, including actual figures etc

https://stocknews.com/what-percentage-of-options-explore-worthless-2019-05/

https://www.thebluecollarinvestor.com/percentage-of-options-expiring-worthless-debunking-a-myth/