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Definition: Automatic Exercise
Automatic Exercise is defined as process where automated exercise of the holder's options takes place, by the Options Clearing Corporation. In case of an in-the-money contract, the strike price is lower than the market price of the instrument so that automatic exercising of this option would produce a profit on this transaction.
The strike price is the price at which one buys the underlying instrument if the contract were exercised. The brokerage firms may have the same policy as the Options Clearing Corporation. The automatic exercise is done if an option is atleast 5 cents in-the-money upon expiration.
For example: - if one buys a call option at 100$ and the stock closes at 100.05$ or higher at the end of trading period on Friday then the option will be exercised automatically. The number of shares multiplied by 100$ will be the amount debited from the option holder’s account even if he has not exercised the option. This was designed to benefit the investor if he fails to exercise his option due to some circumstances. The automatic exercise also is done on the put options as well. If an investor buys a 50$ put and stock closes at 49.95 or lower on closing time Friday then around 50$ multiplied by number of shares amount will be credited into the investor’s bank account. But the automatic exercise does not take into consideration losses to investor. It may also happen that on Monday morning one may be worse off than the call or put option that was automatically exercised.
The point to be understood is that if an investor wants to exercise their option they should do so otherwise inform their broker of the same otherwise the Clearing Corporation has the right to automatic exercise of selling or buying options.