Why are stock options automatically exercised if they are in the money by $.05 or more?

Question

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Answer 1

The automatic exercise of options in the money by a certain amount has been around for many years. It accomplishes two primary purposes.

(1) It reduces the amount of manual activity required at expiration. Most people who have an in the money option at expiration will want to exercise it instead of allowing a contract which has value to become valueless. If you do not have an automatic exercise policy each holder will have to contact his broker who in turn will have to contact the Option Clearing Corporation (OCC). This creates extra work for both the brokers and and OCC.

(2) It offers some protection to option holders. If the option is in the money by a significant amount and the holder forgot (or was unable) to contact his broker, the holder would see a decrease in his net worth if the option expired while his net worth would remain relatively constant if the option is exercised.

The amount the option had to be in the money before it was automatically exercised was only lowered to $0.05 a few months ago. Prior to that it had been $0.25 for a couple of years and before that it was $0.75.

The probelm with the new threshold is that it may cost the small investor money. If you hold two contracts that are in the money by $0.05 at expiration, by definition they are worth $10. If you have a broker that charges more than $10 to exercise the options and/or to close the stock position created, you end up paying more in commissions than you would have lost if you had allowed the options to expire.