Glossary
Exercise
Using the right an option grants: buying the underlying with a call or selling it with a put at the strike price.
To exercise an option is to use the right it gives: a call holder exercises to buy the underlying at the strike price, and a put holder exercises to sell at the strike. Every exercise is matched by an assignment to a seller of the same contract, who must deliver or take the shares. Knowing when exercise happens, and when it does not make sense, is basic options hygiene.
How it works
The holder tells the broker, which passes the instruction to the Options Clearing Corporation (OCC); the OCC assigns it to a clearing member with a short position, which in turn picks one of its customers. American-style options can be exercised on any business day before expiry; European-style options only at expiration.
At expiration, the OCC's exercise-by-exception process automatically exercises equity options that are in the money by $0.01 or more, unless the holder instructs otherwise.
Why most options are sold, not exercised
Exercising early throws away any remaining time value. If that call trades at $8.60, selling it collects $860, while exercising realizes only the $800 of intrinsic value. Early exercise mostly makes sense in narrow cases, such as a deep in-the-money call just before an ex-dividend date when the dividend exceeds the remaining time value. Holders who let an option auto-exercise without the funds can end up with a margin call or a forced sale.