When you exercise an option, you usually pay a fee to exercise and a second commission to buy or sell the shares.. This combination is likely to cost more than simply selling the option, and there is no need to give the broker more money when you gain nothing from the transaction. 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. When you convert a call option into stock by exercising, you now own the shares.
You must use cash that will no longer be earning interest to fund the transaction, or borrow cash from your broker and pay interest on the margin loan. In both cases, you are losing money with no offsetting gain.
Instead, just hold or sell the option and avoid additional expenses. 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.
Occasionally a stock pays a big dividend and exercising a call option to capture the dividend may be worthwhile. Or, if you own an option that is deep in the money , you may not be able to sell it at fair value. If bids are too low, however, it may be preferable to exercise the option to buy or sell the stock. Do the math. There are solid reasons for not exercising an option before and into the expiration date.
In fact, unless you want to own a position in the underlying stock, it is often wrong to exercise an option rather than selling it. 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.
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Your Money. Personal Finance. Your Practice. Popular Courses. 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. As always, you will want to check with your brokerage firm to ensure you understand their policies. Each brokerage firm has a procedure outlined in your account agreement forms. Customers should be familiar with these procedures. The option holder can always submit instructions to their broker regarding whether to exercise or not to exercise.
A customer may decide not to exercise an in-the-money option in some cases. It is best to have an understanding with your broker on actual procedure. They may have a threshold imposed for automatically exercising customer orders. Here is a description of the procedure:. In this procedure, OCC exercises options that are in-the-money by specified threshold amounts unless the clearing member submits instructions not to exercise these options.
Expiring options subject to exercise by exception use the following thresholds to trigger exercise:. Individuals sometimes incorrectly refer to the "exercise by exception" procedure for expiring options as "automatic exercise.
The exercise threshold amounts used in "exercise by exception" trigger "automatic" exercise only in the absence of contrary instructions from the clearing member. Because the right of choice is always involved in "exercise by exception," exercise under these procedures is not, strictly speaking, "automatic. The exchanges that list the products will have that information available on their websites.
You will need to check the specifications of each product you intend to trade. An investor might look at the premium of a call option to determine likelihood of early assignment. An option's premium consists of two parts: intrinsic value and time value. Intrinsic value is the amount by which an option is in-the-money. Time value is the premium amount in excess of the intrinsic value. When an option holder exercises an option early, they forfeit any time value priced into the option.
This is one reason that an option holder might not exercise an option early. An option writer should consider the perspective of the option holder. The option holder most likely makes his or her decision to exercise or sell the option on the most profitable outcome. In the above example, if the investor wanted to own the underlying stock, the choice to sell the option and use the option proceeds to buy the underlying stock might be the more profitable alternative.
Finally, OCC randomly assigns exercise notices to its clearing members who, in turn assign their customers. Ask your brokerage firm how it allocates assignments. If your plan is to meet your stock delivery obligation by exercising your long call, discuss this with your broker and give your brokerage firm exercise instructions for the long call. As the ex-date for a dividend approaches, there is increased likelihood that call holders will exercise in-the-money calls.
Because call holders seek to capture an impending dividend by exercising, a call writer's chances of assignment may increase as the ex-date for a dividend on the underlying security nears. Learn more by visiting our learning center, Introduction to Spreading. A call holder is entitled to the dividend if the holder exercises the call prior to the ex-dividend date. College Planning Accounts. Small Business Accounts. Open an account.
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Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled " Characteristics and Risks of Standardized Options PDF " before considering any option transaction.
You may also call the Investment Center at A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge. The holder of an American-style option can exercise their right to buy in the case of a call or to sell in the case of a put the underlying shares of stock at any time.
The holder of a European-style option can only exercise their right at expiration. Both contract styles can be closed on the option's market at any time. The brokerage firm notifies OCC that an option holder wishes to exercise an option. OCC then randomly assigns the exercise notice to a clearing member. For an investor, this is generally his brokerage firm chosen at random from a total pool of such firms.
The firm must then assign one of its customers who has written and not covered that particular option. Assignment to a customer is either random or on a first-in-first-out basis.
Merrill handles assignment on a random basis when the OCC assigns an exercise notice. Select to close help pop-up An option is at the money if the strike price of the option is equal to the market price of the underlying security. Select to close help pop-up A call option is out of the money if the strike price is greater than the market price of the underlying security.
A put option is out of the money if the strike price is less than the market price of the underlying security. The holder of an American-style option contract can exercise the option at any time before expiration.
Therefore, an option writer may be assigned an exercise notice on an open short option position at any time before expiration. If an option writer is short an option that expires in-the-money, they should expect assignment on that contract, though assignment is not guaranteed as some long in-the-money option holders may elect not to exercise in-the-money options. In fact, some option writers are assigned on short contracts when they expire exactly at-the-money Hover to view help pop-up Select to view help pop-up An option is at the money if the strike price of the option is equal to the market price of the underlying security.
This occurrence is usually not predictable. To avoid assignment on a written option contract on a given day, the position must be closed out before that day's market close.
Once assignment is received, an investor has no alternative but to fulfill assignment obligations per the terms of the contract. There is generally no exercise or assignment activity on options that expire out-of-the-money.
Owners usually let them expire with no value. Although this is not always the case as post-market underlying moves may lead to out-of-the-money options being exercised and in-the-money options not being exercised. When an investor exercises a call option, the net price paid for the underlying stock on a per share basis is the sum of the call's strike price plus the premium paid for the call.
Likewise, when an investor who has written a call contract is assigned an exercise notice on that call, the net price received on per share basis is the sum of the call's strike price plus the premium received from the call's initial sale.
When an investor exercises a put option, the net price received for the underlying stock on per share basis is the sum of the put's strike price less the premium paid for the put. Likewise, when an investor who has written a put contract is assigned an exercise notice on that put, the net price paid for the underlying stock on per share basis is the sum of the put's strike price less the premium received from the put's initial sale.
If the client holds long in his or her account U.
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