Call and put option contracts give you the right to buy and sell the underlying shares at specified prices, known as strike prices, before predetermined expiration dates. You do not have to exercise these rights if you decide to sell the options.
Is it optimal to early exercise an option? (FRM T3-36)
When you exercise a call option, you would buy the underlying shares at the specified strike price before expiration. Step 1 Compare the strike price of the call option to the current stock price.
You would exercise your rights and buy the shares only if the call option is in the money, meaning the strike price is less than the stock price. Step 2 Review the company fundamentals, such as earnings growth and consistent cash flow.
Exercise means to put into effect the right to buy or sell the underlying financial instrument specified in an options contract.
You should be able to find the relevant information in quarterly financial statements posted on the company's investor relations website. If the fundamentals are sound and the outlook is bright, you could exercise your call options and hold on to the shares for long-term capital gains.
Step 3 Exercise an option the profits from selling your call options versus exercising them. Your profits would be 10 cents a contract if you exercise an option to close out the call position, which is a 20 percent return on investment.
Step 4 Exercise call options if you are using them to hedge a short sale and the stock price continues to rise. A short sale involves selling shares that you borrow from your broker in the expectation that you can buy them back at lower prices. If the stock rallies instead, call options with the appropriate strike price could prevent losses because you could exercise the calls to cover your short position.
Tip The Options Clearing Corporation automatically exercises options if they are in the money by one cent or more. Your broker may have different procedures for automatic exercises.
Article Reviewed on July 30, Michael J Boyle Updated July 30, As you learn about trading optionsyou'll find that options traders use terms that are unique to options markets. You'll see these terms appear often and understanding them can have a significant effect on your chances for profitability on an options trade. Defining Options Before getting into options terminology, it's helpful to get some background on options themselves.