I used to understand the option exercise panel in TWS.. I'd select "lapse (do not exercise)", and something would be set indicating that the options would not be exercised. But I tried it a few minutes ago with FB $29 options that expire today and were about to go in the money. TWS popped up a message saying that I could not have an order on both sides of the market. It cancelled my limit order to sell at $.80 and TWS shows a filled buy order for $0.0. My trades panel and audit trail show that my position was sold for $0.0. All this while the market was $.10x$.15, with hundreds of contracts showing at the bid and ask. Did I misunderstand what setting option exercise does?
When you select "Lapse," you are indicating that you want the option to be removed from your portfolio. You cannot trade it after that. If you want to trade out of the position, there is no reason to select Lapse first. If you fail to close out the position and you don't want it to get exercised, you can select Lapse after the market has closed.