How to Exercise an Option
When you buy options, you are buying the right (but not the obligation) to buy or sell shares of the underlying stock at a specific price, called thestrike price. When youexercisethe option, you complete the action you bought the right to do. American-style options can be exercised at any time, whereas European-style options can only be exercised on their expiration date. You can also make money with options by selling the contracts themselves, or by offsetting them with opposing options. Options trading is an advanced investment strategy that comes with considerable risks. Be cautious if you're a beginning investor.
Calling and Putting Options
Compare the price of the underlying stock to your strike price.When you exercise your option, you buy (call) or sell (put) the underlying stock at the price stated in the contract. If your options have value relative to the actual stock price, you are "in the money."
- A call option allows you to buy stock at the stated strike price. You'll make money if the stock is trading at a higher price than your stock price, because you can buy shares at your lower strike price. You could then turn around and sell those shares at the actual price to make money.
- If you have put options, you have the right to sell stock at the strike price listed on your contract. You'll make money if you exercise your options when the stock is selling at a much lower price on the open market. You are essentially forcing someone to buy shares at a higher price. You can then buy more shares at the lower price, or simply pocket the difference.
- For example, if you own a call option for stock at the strike price of , and the stock is currently selling at 0, you are "in the money" because you can buy the stock for half the price it's actually trading for. Likewise, if you owned put options for stock at the strike price of 0, and it is currently selling at , you are "in the money" because you can force someone to buy the stock at twice the price it's currently trading for.
Evaluate the time value of your option.If you have American-style options, you can exercise them at any time – you don't have to wait until the expiration date. Exercising an option well before the expiration date means losing potential value. However, waiting it out comes with a risk that the stock price won't move the way you've predicted.
- For example, suppose you are in the money on call options that don't expire for 6 months. You could exercise them now and buy the stock at your strike price. However, if the stock continues to rise, you could potentially make more money by exercising the option later.
- Even with American-style options, most options aren't exercised until close to their expiration date. This gives options holders the opportunity to maximize the time value of their options.
Check your account balance.To exercise a put option, you must first own the underlying stock. If you're exercising a call option, on the other hand, you need the resources to purchase the underlying stock at the strike price.
- Your broker may have its own rules about how much money you need to have in your account to exercise your options. Call customer service or check the educational resources on your broker's website for specific rules.
Instruct your broker to exercise the option.You can't trade options without a broker. If you have an online broker, you may not have to do anything more than click a button. Your broker will take several steps behind the scenes to exercise your options for you.
- The process is somewhat complex, but in reality it typically only takes a few minutes.
- You don't have any sort of relationship with the investor who is assigned the options you exercise. In fact, you likely won't even know who they are. The process is done electronically by the relevant options clearing house.
Offsetting an Option
Evaluate the risk in your options position.Trading options is inherently risky, but offsetting options can minimize the risk involved. However, when you minimize risk, you may also lessen your opportunity to profit from your position.
- For example, suppose you own put options with a strike price of . The stock is currently selling at 0, so you are out of the money. You could buy call options with a strike price of (if they're available) to offset that risk. While you'd lose money on the put options, you'd gain an equal (or near-equal) amount on the call options for a zero net gain.
Calculate premiums, commissions, and fees.When you buy additional options, you'll have to pay commissions and fees to your broker, plus a premium to the seller of the options. If you don't own the stock on which your options contracts are based, offsetting the options can cost you less in commissions and fees than if you exercised the option or sold the contracts themselves.
Find a series that matches your options exactly.The only way you can use offsetting to close your position entirely is if you purchase options with exactly the same strike price and expiration date as the options you currently hold.
- If the options don't match exactly, they can still minimize the risk your position is exposed to, but they won't close out your position.
- For example, suppose you hold 3 put options contracts with an expiration date of January 1 and a strike price of . You can offset those contracts only with 3 call options contracts that have a strike price of and also expire on January 1. If your call options expire on January 15, they potentially have greater time value than your put options and don't fully close out your position.
Purchase opposing options to close out your position.If you have call options, you would need to buy put options of the same underlying stock at the same strike price and with the same expiration date.
- If you have an online broker, typically all you'll have to do is find the correct series and click a button to purchase opposing options. Make sure you buy the same number of contracts for the opposing position as you did for your original position to fully close it out.
- For example, if you own 5 put options contracts with a strike price of that expire on January 1, you would need to buy 5 call options contracts with a strike price of on the same underlying stock that also expire on January 1.
Selling the Options Contracts
Evaluate the cost in exercising the option.In some situations you'll be better off selling your option than exercising it. Particularly if you have to first buy the underlying stock, you may have to pay additional commissions and fees.
- For example, if you have a put option, you must first own the underlying stock before you can exercise the option to sell it at your strike price. You'll typically pay commissions on the initial stock purchase, and then additional commissions and fees when you exercise your option.
- Your costs may be lower if you have a call option, since you don't have to buy the stock beforehand. However, your broker's fees still may be lower for selling the contracts themselves than for exercising the options.
Analyze the option's potential.You can calculate the basic value of an option by comparing the strike price to the actual price of the stock. However, there are other external factors that can affect the value of an option to another investor, such as the quality of the underlying stock and its performance.
Instruct your broker to sell your contracts.If you have an online broker, you typically can sell your options contracts with the click of a button. You don't need to own the underlying stock to sell the contracts themselves.
- When you sell your options contracts on an exchange, you may capture more value because you can take advantage of any value added by external factors, such as demand for the underlying stock.
- Discuss any questions you have about pricing with your broker before you execute the sale of your contracts.
Check your account balance.Once your options are sold, your profit will be deposited into your trading account, less any commissions or fees for the transaction. Since no stock was traded, this is a cash transaction.
Video: Options Exercise Process
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