General Securities Representative (Series 7) Practice Exam

What happens to outstanding option contracts that are in the money by $.01 or more on the expiration date?

1. They are cancelled

2. They expire worthless

3. They are automatically exercised

4. They can be rolled over

The correct answer is: They are automatically exercised

Outstanding option contracts that are in the money by $.01 or more on the expiration date are automatically exercised. This automatic exercise feature is designed to ensure that option holders benefit from their profitable positions without needing to take any additional action. When an option is in the money, it has intrinsic value; for instance, a call option that allows the purchase of a stock at a strike price lower than the current market value is beneficial to the holder. This automatic exercise policy is relevant in ensuring that traders can realize gains, as options tend to be held until their expiration. It's important for traders to be aware of this mechanism, as they may need to manage their underlying securities positions accordingly. Those who might want to avoid exercising an option must take action ahead of expiration. The other choices reflect processes that do not occur with in-the-money options at expiration. For example, cancellation and expiration of worthless options pertain to contracts that do not hold value and have no profit potential. Rollover pertains to strategies involving the further extension of options beyond their current expiration, which does not apply to the automatic exercise of in-the-money contracts. Understanding this automatic exercise feature is crucial for successfully navigating expiration dates in options trading.