EFTA01353442.pdf

CHAPTER VIII EXERCISE AND SETTLEMENT Although most option holders and writers close out their options positions by an offsetting closing transac- tion, investors should nonetheless be familiar with the rules and procedures applicable to exercise. Such an understanding can help an option holder determine whether exercise might be more advantageous than an offsetting sale of the option. An option writer needs to understand exercise procedures because of the possibility of being assigned an exercise. Once an exercise of an option has been assigned to an option writer—even though he may not yet have been notified of the assignment—the writer can no longer effect a closing transaction in that option but must instead pur- chase or sell the underlying interest for the exercise price (or, in the case of a cash-settled option, pay the cash settlement amount). HOW TO EXERCISE The period during which an option is exercisable depends on the style of the option. This is discussed under "Style of Option" in Chapter II. In order to exercise most options traded at the date of this booklet, action must be taken by the option holder prior to the expiration of the option. However, some options may be subject to automatic exercise. For example, capped options are subject to automatic exercise if the automatic exercise value of the underly- ing interest hits the cap price for the option, and certain other options are subject to automatic exercise at expi- ration if they are then in the money (or, in the case of some options, in the money by a specified amount). To exercise an option that is not subject to automatic exercise, the holder must direct his brokerage firm to give exercise instructions to OCC. In order to ensure that an option is exercised on a particular day. the holder must direct his brokerage firm to exercise before the firm's cut-off time for accepting exercise 49 CONFIDENTIAL - PURSUANT TaffiESERNDS0M810 P. 6(e) CONFIDENTIAL SDNY_GM_00183994 EFTA01353442