That's a question that investors sometimes struggle with because it's not always clear if it's the optimal time to call buy the shares or put sell the stock when holding a long call option or a long put option.
There are a number of factors to consider when making the decision, including how much time value is remaining in the option, whether the contract is due to expire soon, and whether you really want to buy or sell the underlying shares.
Exercising Stock Options
Conversely, a put option represents the right to sell the underlying shares. Key Takeaways Knowing the optimal time to exercise an option contract depends on a number of factors, including how much time is left until expiration and if the investor really wants to buy or sell the underlying shares.
In most cases, options can be closed rather than exercised through offsetting transactions prior to expiration. It doesn't make a lot of sense to exercise options that have time value because that time value will be lost in the process.
Holding the stock rather than the option can increase risks and margin levels in the brokerage account. The important thing to understand is that the option owner has the right to exercise.
When you first start out trading options you should be aware of one very important fact; it isn't necessary to exercise in order to make a profit. A lot of beginner traders look to make profit by exercising options when there's a return to be made, but this isn't the only way to make money and it's rarely the right thing to do. Statistics have shown that traders tend to make their returns through closing positions by buying or selling options rather than exercising them. This is basically because it's usually more profitable to do so.
If you own an option, you are not obligated to exercise; it's your choice. As it turns out, there are good reasons not to exercise your rights as an option owner. Instead, closing the option selling it through an offsetting transaction is often the best choice for an option owner who no longer wants to hold the position.
Obligations to Options While the holder of a long option contract has rights, the seller or writer has obligations. Remember, there are always two sides to an options contract: the buyer and the seller.
Exercise means to put into effect the right to buy or sell the underlying financial instrument specified in an options contract. In options trading, the holder of an option has the right, but not the obligation, to buy or sell the option's underlying security at a specified price on or before a specified date in the future. If the owner of an option decides to buy or sell the underlying instrument—instead of allowing the contract to expire, worthless or closing out the position—they will be "exercising the option," or making use of the right, or privilege that is available in the contract. The decision to exercise an option isn't always a clear-cut one.
The obligation of a call seller is to deliver shares at the strike price. The obligation of a put seller is to purchase shares at the strike price. When the seller of an option receives notice regarding exercise, they have been assigned on the contract.
The key things to know about managing options, including exercise, assignment, and roll.
At that point, the option writer must honor the contract if called upon to fulfill the conditions. Once the exercise of options notice is delivered, it is too late to close the position, and they are required to fulfill the terms of the contract.
The exercise and assignment process is automated and the seller, who is selected at random from the available pool of investors holding the short options positions, is informed when the transaction takes place. Thus, stock disappears from the account of the call seller and is replaced with the proper amount of cash; or stock appears in the exercise of options of the put seller, and the cash to buy those shares is removed.
Each call option gives the right to buy shares at the strike price. October expiration is in two weeks.
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- Best Option Brokers Definition of Exercising Options: Calls and puts give the owner the right to buy or sell a stock at a certain price by a certain date.
Time Value A number of factors determine the value of an option, including the time left until expiration and the relationship of the strike price to the share price. If, for example, one contract expires in two weeks and another contract, on the same stock and same strike price, expires in six months, the option with six months of life remaining will be binary options bonuses more than the one with only two weeks.
It has greater time value remaining. A contract that is out-of-the-money say an Oct callconsists only of time value.
It rarely makes sense to exercise an option that has time value remaining because that time value is lost. Furthermore, it rarely makes sense to exercise an out-of-the-money contract. Let's assume one week has passed and the company makes an unexpected announcement. That's unfortunate.
Transaction Costs When you sell an option, you typically pay a commission. However, the costs will vary, and some brokers now offer commission-free trading—so it pays to do the math based on your broker's fee structure.
Higher Margin Exposure When you convert a call option into stock by exercising, you now own the shares. Options are subject to automatic exercise at expiration, which means that any contract that is in the money at expiration will be exercised, per rules of the Options Clearing Corporation.
Should an Investor Hold or Exercise an Option?
Do the math. The Bottom Line There are solid reasons for not exercising an option before and into the expiration date.
If the contract is in the money heading into the expiration and you do not want it exercised, then be sure to close it through an offsetting sale or the contract will be automatically exercised per the rules of the Options Clearing Corporation. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
You can learn more about the standards we exercise of options in producing accurate, unbiased content in our editorial policy.
Options Clearing Corporation. Accessed Oct. Compare Accounts.