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. There are several factors that need to be considered before making the decision; however, more often than not, it's safer to hold or sell the option instead.
Exercising Put and Call Options An options holder may exercise his or her right to buy or sell the exercise of an option underlying shares at a specified price—also called the strike price. Exercising a put option allows you to sell the underlying security at a stated price within a specific timeframe.
- 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.
- 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.
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- Exercising Options - How and Why to Exercise an Option
Exercising a call option allows you to buy the underlying security at a stated price within a specific timeframe. To exercise an option, you simply advise your broker that you wish to exercise the option in your contract.
The key things to know about managing options, including exercise, assignment, and roll. Essentially, there are 4 things you can do if you own options: hold them, exercise them, roll the contract, or let them expire. If you sell options, you can also be assigned.
Your broker will initiate an exercise noticewhich informs the seller, or writer of the contract that you are exercising the option.
Key Takeaways In options trading, "to exercise" means to put into effect the right to buy or sell the underlying security that is specified in the options contract. If the holder of a put option exercises the contract, then he will sell the underlying security at a stated price within a specific timeframe.
If the holder of a call option exercises the contract, then she will buy the underlying security at a stated price within exercise of an option specific timeframe. Before exercising an option, it is important to consider what type of option you have and whether you can exercise it. Unexercised Options The majority of options contracts are not exercised but, instead, are allowed to expire, worthless, or are closed by opposing positions.
For example, the holder of an option can close out a long call or put prior to expiration by selling it, assuming the contract has market value. If an option expires unexercised, the holder no longer has any of the rights granted in the contract.
- What it Means to Exercise an Option?
- Styles[ edit ] The option style, as specified in the contract, determines when, how, and under what circumstances, the option holder may exercise it.
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- Should an Investor Hold or Exercise an Option?
In addition, the holder loses the premium he or she paid for the option, along with any commissions and fees related to its purchase. This is very important, as contracts have different guidelines. American-style contracts allow you to exercise them before their expiration date.
European options may be exercised only after the contract has expired. Can you exercise your options?
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. Conversely, a put option represents the right to sell the underlying shares. Key Takeaways Knowing the optimal time to exercise an exercise of 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.
In some cases, such as employee stock ownership video training options trading ESOPsyour shares may be vestedmeaning that you will need to wait a set amount of time before you exercise the option. Will the cost outweigh the benefits?
Disadvantages of Exercising
Exercising a contract costs you commission money, so make sure that the exercise price will make you money; otherwise, you'll end up paying more in fees and you will lose out on any potential profit. Are there taxes involved?
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.
You will want to consider any tax implications associated with the type of contract you are exercising because, for example, an employee cashing out an ESOP will have to pay additional tax. Compare Accounts.