The clearing house rule that automatically exercises options finishing in the money by a threshold amount, unless the holder instructs otherwise.
Rather than requiring every holder to file an exercise notice, the occ exercises in-the-money contracts automatically. A holder who does not want that must submit contrary instructions before the broker's deadline, which is usually well before the official cut-off.
This is how small accounts end up owning stock they cannot pay for. A one-cent-in-the-money long call with no cash behind it still gets exercised and still creates a $5,000 debit.
Example: XYZ closes at $50.02 and you hold one long $50 call bought for $0.40. It is $0.02 in the money — worth $2 — so it is exercised automatically. Monday you own 100 shares for $5,000. If your account holds $1,200, you get a margin call and a forced liquidation.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Buying a call: payoff at expiry. A 105-strike call bought for 3 loses that whole 3 if the price finishes at or below 105, breaks even at 108, then gains a dollar for every dollar higher. The loss is capped at the premium; the upside is not capped.Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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