Each brokerage firm has a procedure outlined in your account agreement forms. Customers should be familiar with these procedures. The option holder can always submit instructions to their broker regarding whether to exercise or not to exercise. A customer may decide not to exercise an in-the-money option in some cases. It is best to have an understanding with your broker on actual procedure. They may have a threshold imposed for automatically exercising customer orders. OCC uses the $.01 threshold for the positions of its clearing members as an administrative convenience, but your firm may have a different threshold. Here is a description of the procedure:
EXERCISE BY EXCEPTION
"Exercise by exception" is an administrative procedure used by OCC to expedite the exercise of expiring options by clearing members. In this procedure, OCC exercises options that are in-the-money by specified threshold amounts unless the clearing member submits instructions not to exercise these options. "Exercise by exception" is a procedural convenience extended to OCC clearing members, which relieves them of the operational burden of entering individual exercise instructions for every option contract. It is important to note "exercise by exception” is a procedure between OCC and its clearing members and is not intended to prevent the need for customers to communicate exercise instructions to their brokers:
"The exercise thresholds provided for in Rule 805(d) and elsewhere in the rules are part of the administrative procedures established by the Corporation to expedite its processing of exercises of expiring options by clearing members, and are not intended to dictate to clearing members which positions in customers’ accounts should or must be exercised." (Rule 805, Interpretation .02)
Expiring options subject to exercise by exception use the following thresholds to trigger exercise:
Equity options: $.01 per contract in-the-money in the customer account; $.01 per contract in-the-money in firm and market maker accounts. Index options: $.01 per contract in-the-money in all account types.
The difference between the exercise price and the “closing price” of the underlying security determine whether expiring options are in-the-money or not.
Individuals sometimes incorrectly refer to the "exercise by exception" procedure for expiring options as "automatic exercise." It is important to note "exercise by exception" always allows an OCC clearing member to make a choice not to exercise an option that is in-the-money by the exercise threshold amount or more, or to exercise an option that has not reached the exercise threshold amount. The exercise threshold amounts used in "exercise by exception" trigger "automatic" exercise only in the absence of contrary instructions from the clearing member. Because the right of choice is always involved in "exercise by exception," exercise under these procedures is not, strictly speaking, "automatic."
TO MINIMIZE THE POTENTIAL FOR ERROR CUSTOMERS SHOULD COMMUNICATE TO THEIR BROKER OR CLEARING MEMBER EXPLICIT INSTRUCTIONS TO EXERCISE, OR NOT EXERCISE, ANY EXPIRING OPTION CONTRACT.