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The Options Clearing Corporation (OCC) has the broad responsibility for orderly settlement of all option contracts, which takes place through contact between brokerage houses and customers working with the exchange. Orderly settlement means, generally, that buyer and seller both trade in confidence, knowing that they will be able to execute their orders when they want, and finding a ready market. It also means that all terms of the contract are ironclad; exercise price, expiration date, and availability of shares upon exercise are all a part of the orderly settlement. To ensure orderly settlement and in recognition of the probability that option buying and selling does not always match up, the OCC acts in the capacity of buyer to every seller, and as seller to every buyer.
When a customer notifies a broker and places an order for execution of an option trade, the OCC ensures that the terms of the contract will be honored. Under this system, buyer and seller do not need to depend upon the goodwill of one another, the transaction goes through the OCC, which depends upon member brokerage firms to enforce assignment. Buyers and sellers are not matched together one-on-one. A disparate number of open buy and sell options are likely to exist at any given time, so that exercise will be meted out at random to options in the moneythus the term assignment. Since buyers and sellers are not matched to one another as in other types of transactions, how does a seller know whether a specific option will be exercised? There is no way to know. If your short option is in the money, exercise could occur at any time. It might not happen at all, or it might take place on the last trading day.
When exercise occurs long before expiration date, that exercise is assigned to any of the sellers with open positions in that option. This takes place either on a random basis or on the basis of first-in, first-out (the earliest sellers are the first ones exercised). Upon exercise, 100 shares must be delivered. The concept of delivery is in relation to the movement of 100 shares of stock from the seller of the option to the exercising buyer. The buyer makes payment and receives registration of the shares, and the seller receives payment and relinquishes ownership of the shares.
Tip: The seller often can avoid exercise through a series of stepspicking out-of-the-money options, taking short-term profits, and exchanging short-term options for longer-term ones. Avoiding exercise makes sense when stock price movement justifies it.