Buyers of call options
An American-style call option contract gives the holder the right, but not the obligation, to buy 100 shares of the underlying security at a specific price from the point of purchase until the option expires. When the holder or buyer of the options contract decides to own the underlying security, he can exercise the option and purchase the underlying security at the exercise price. If the option is not exercised, the option will expire worthless and cease to exist as a financial instrument. The trader or investor who holds an option in his/her trading account is said to have a position in that contract.
The holder of the option contract must submit a notification of intent to his brokerage firm if he wishes to purchase the underlying security. Usually, this must be done by a certain cut-off date as set by the broker.
Buyers of put options
An American-style call option contract gives the holder the right, but not the obligation, to sell 100 shares of the underlying security at a specific price from the point of purchase until the option expires. When the holder exercises that right, he gets to sell shares at the strike(exercise) price of the contract. When the option is not exercised, it will expire worthless after the expiration date.
Now we know that the option buyer is the holder or owner an option contract. However, which party will sell an option contract to the option buyer? Here, one of 2 scenarios will play out. An option writer can write an option contract and sell it to an option buyer. Either that or an existing option holder can sell an option contract to the option buyer.
Typically, the parties who sell option contracts to option buyers are professional traders who are members of an exchange or are investors or retail traders. The professional traders create bid and ask prices surrounding an option contract. It is their duty and obligation to create markets out of these contracts.
Call writers and put writers
Since call and put buyers have the right to to buy or sell the underlying security, call writers and put writers on the other hand have an obligation to sell or buy the underlying security. This shows the contrasting roles that writers play as opposed to the role that buyers play. The writer of the call option is obligated to sell the underlying security to the call buyer while the writer of the put is obligated to buy the underlying security from the put buyer if the buyers decide to exercise their options.
When must the obligation to buy or sell the underlying security from the option buyers be met?
The option writer will be notified by his brokerage firm through an assigned exercise notice. When that happens, the writer must fulfil the obligation within 3 days of the exercise date.
When an option is sold, it is said to be written by the seller. Therefore, the option seller is also known as an option writer. Option writers have the obligation to buy or sell the underlying security when the buyer of that said options contract chooses to exercise the right to buy or sell shares. This is called assignment. Assignment takes place when the the option owner exercises the right to buy or sell the underlying security depending on whether it is a put option contract or call option contract.
To make this clearer, imagine a transaction where Trader A buys a call option contract from Trader B. Trader B is thus the option writer and Trader A is the option buyer or holder. When Trader A exercises his contractual right to buy 100 shares at a strike(exercise) price of $10, Trader B must sell 100 shares at $10 per share to Trader A. When Trader A exercises his right as a call option contract holder, Trader B who took the other side of the trade has to sell to him 100 shares.
Now imagine a transaction where Trader A buys a put option contract from Trade B. When Trader A exercises his right to sell shares at the strike(exercise) price of $10, Trader B has the obligation to buy those 100 shares of the underlying security at a price of $10 from Trader A.
Options are seldom exercised
The truth is options are rarely exercised. Most of the time, traders prefer to close these positions. Only about 18% of all options are ever exercised. If you are starting out as an options trader, you may choose to close the position instead to save you the hassle of buying and selling shares of the underlying security.
As a beginner options trader, you might just want to think about buying low and selling high for starters. Buy your option for cheap and sell it(close the position) for a high price when the premium increases. Or you could sell your option at a high price and buy it back(close the position) at a low price.
Option holder decides when to exercise or sell
When an option holder has an outstanding option contract, that is, a long position, he has the right to buy or sell the underlying security at a specified price on or before the expiration date. If the option expires worthless or is already exercised, the right ceases to exist. Besides exercising the option, the option holder can also sell the option(sell to close) in the open market. This is what many option traders do. When the option premium increases, option traders can choose to sell to close the position at a profit.