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An exercise limit is a type of maximum number of options contracts that a single investor can exercise within a given time period. The idea behind this type of limitation is to minimize the opportunity for an investor exercising an unusually high number of options on the same underlying asset within a short period of time, a situation that could have severe repercussions in the marketplace. Typically, the time period that applies to the exercise limit is five trading days, with some exceptions to the rule applying during the last ten-day period before the options contracts reach maturity.
One of the best examples of an exercise limit is found with the Chicago Board Options Exchange (CBOE). The exchange has specific limits placed on options contracts and derivatives, with the limit being no more than 5,000 contracts associated with a given underlying asset over the course of five consecutive trading days. This means that if an individual or corporate investor holds more than 5,000 contracts connected with a particular option, some of those contracts cannot be exercised until five trading days have passed and some of the recently exercised contracts have not been acted on for at least five days.
The benefit of placing some sort of exercise limit on options contracts regarding the same underlying asset is that there is less of a chance of creating instability within that market or exchange. The limit effectively prevents too-frequent transactions that could allow a single investor or group of investors from gaining control of the market to the detriment of other investors. This in turn means that market movements are less likely to have an unusually strong impact on the economy in general, and create hardship for people who do not even trade in that market.
While an exercise limit usually focuses on only allowing a certain number of options with a common underlying asset to be exercised in a defined period of time, most exchanges do allow some exceptions. The limit can be suspended for a short period of time, if doing so is not in contrast to trade regulations imposed by a government, and if there are compelling reasons to think that the activity would help reverse some sort of adverse events within that marketplace. In addition, the exchange may also waive the limit on contracts that are about to mature or expire, usually for the last ten trading days before that expiration is set to occur.