The Rules For Exercising Options

You probably know that a Call option gives you the right to buy a stock at a fixed price, and that a Put option gives you the right to sell a stock at a fixed price. These rights are what give the option its value. When you take advantage of these rights it is called exercising options.

When Should You Exercise Option Calls or Puts?

Under what conditions would one want to exercise the rights the option gives? The answer is that exercising options is almost never beneficial. Only a small fraction of the options that are created are ever exercised, and for good reason.

Does this mean that most option buyers are buying something worthless? Not at all. It just means that there is almost always a more profitable way to close out an option trade than by exercising it.

First let’s look at call options, which give you the right to buy the stock. When you buy a call option, there are three ways that the trade could play out, at your discretion:

You could do nothing with the call, allowing it to expire. In this case you would lose whatever money you had paid for the call.

You could exercise the option call. This means buying the stock and paying the strike price for it. Your total investment would then be the option price paid plus the strike price. This would be profitable if the stock has gone up past your strike price by more than the premium you paid for the call. If the stock is above the strike price by a lesser amount than the premium paid, exercising it will result in a small loss. And if the stock is below the strike price, you would obviously not exercise it, since this would involve paying more than the market price for the stock.

Finally, you could sell the call option before it expires. The option itself has a market value that is constantly changing. It can be sold at any time for its then-current market value. As the stock price goes up or down, the price of the call does the same. You would have a profit if you sold the call for more than you paid for it originally; if you sold it for less you would have a loss.