Forget exercise. Only a few advanced traders use it.
If your long option is in-the-money, you want to "sell to close" before expiration. If not, it will expire worthless and you don't need to do anything.
For example, let's say I'm bearish on the stock of "Company A" which trades at $150 now and I BUY the 30-May-2014 145 PE Contract at a premium of $5, since I hope the price of "Company A" will stay below $145 (my strike price) for the rest of May. The lot size is 250 and my breakeven point is $140. Now, suppose my prediction goes right and on Expiry day "Company A" quotes at $130 per share and my PUT Option is profitable by $2500 ($10*250).
But, at the same time, I don't have any shares of "Company A" in my account holdings, whereas the PUT Options contract means I have to sell 250 shares since I have continued holding it till Expiry.
Now what happens? Will this contract get exercised automatically by the Exchange on Expiry day? But I don't own any "Company A" shares! If I become "SHORT" in it, do I become "SHORT" in its Futures (which I want to avoid)?. Or will I be forced to BUY 250 shares of "Company A" from the market at the market price of $130 with my own money and sell it at $145 (my strike price)? And what if I don't have so much money ($130*250 = $32500) to make the initial buy for the profitable sell?! Then what?!
Can someone explain what basically happens?
Thanks!
