DEFINITION of Exercise Limit

An exercise limit is a restriction on the amount of option contracts of a single class that any one person or company can exercise within a fixed time period (usually a period of five business days). This limit is in place so that no one person or company can corner or greatly impact the options market or the market in the underlying security.

Along with position limits, these restrictions help keep markets fair and efficient.

BREAKING DOWN Exercise Limit

Option exercise limits, along with position limits, have been in place since the creation of standardized trading of options in the United States and elsewhere. The purpose of these limits is to prevent manipulation or unethical actions in underlying securities markets (such as corners or squeezes) as well as disruptions in options markets where illiquidity in a given option class exists.  These limits prohibit an account, along with any other accounts controlled by the same entity, from cumulatively exercising in excess of a pre-determined number of options contracts for a given set of options contracts associated with a particular underlying security. This includes both situations involving early exercises and expiration exercises.

If the exercise limit was not in place, a trader could purchase enough call options and then exercise them to own enough of the underlying asset to control most of the market. In stocks, this means that a bad actor could effect a takeover a company and its controlling votes through the exercise of options alone. In commodities markets, it could allow a bad actor to corner the market and artificially inflate the price of products such as silver, crude oil, or soybeans. 

In the case of disrupting illiquid options markets, an exercise of a long option will always result in the assignment of a short options position. This means that many unsuspecting options writers will suddenly be placed in long or short positions in the underlying stock. As these traders try to exit or re-establish their prior positions, the prices of the options contracts, being illiquid, could swing wildly.

Example of Exercise Limits

For example, copper options on the CBOE may have a five-day exercise limit of 5,000 contracts, meaning no person or group can exercise more than 5,000 copper contracts over any five-day period.

For equity options on stocks, the exercise limit will often depend on the volume and liquidity  of the underlying security, and can be changed pending review by an exchange and the Securities and Exchange Commission (SEC).