SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Early Exercise: Call Options


How would a trader like you decide to do early exercise? Say you bought calls when they were trading in the 1.0 -> 2.5 range, now underlying has risen so that calls trade bid-ask at 4.0 / 4.8 and there is strong possibility of it going higher. Also assume in another case that they trade in the 6.0 to 7.0 range.

What would make you wait for early exercise till Wednesday morning, Thursday morning, Friday morning of expiry week as a trader? Assume you have cash to buy all contracts. The time value is negligible, and theta is eroding it fast.

 

Would you change your mind if the risk-free interest rate was say 8% and not 0-1% as currently?  Is that rate a huge factor for 2-4 days anyway?

 

I read some books where a bunch of math experts say that except for a dividend-paying underlying, early exercise is impossible.

 

Personally, if I were the call buyer and I had bazillion money, I would not sell the calls as the bid/ask spread widens and the market makers play games. I would choose early exercise sometime on late Wednesday or anytime Thursday to remove option spread slippage, so I buy underlying at the strike price and immediately sell it to lock in profit, because underlying spread is narrower than the option spread.

 

Answer:

 

This is a very easy question.

 

1) I WOULD NEVER, exercise a call option prior to expiration – UNLESS it is to capture a dividend.

 

Before I go further, there are three valid reasons why someone may want to exercise a call option early.  My guess is that >99% of all option traders will never encounter these situations. 

 

  1. If there is a dividend, sometimes a call owner must exercise the option or it is throwing money into the trash.  The call must be ITM, the delta must be 100 and the option should not be trading over parity. 
  2. A professional trader (market maker) may prefer to sell stock short to hedge some trades.  If he/she does not own long stock, then when expiration is near,  deep ITM calls can be exercised and the long stock immediately sold. That is not as good as selling short stock, but must suffice when there are no better alternatives.
  3. When expiration is near and the call option is deep ITM, sometimes the option bid is below parity.  In that situation – and it is not that common because most traders do not hold onto options that move deep into the money – then it's often better to exercise and immediately sell stock than it is to sell the call. 
  4. Selling the call is preferable because it saves commission dollars.  But if the bid is too low, then the trader may have to exercise.

These situations exist, and I mention them for the purist.  However, my contention remains that if you are a retail investor, you can easily go your entire lifetime and never exercise a call option – or have any reason to do so.

 

A smart retail trader NEVER exercises a call option.  What can be gained?  Think about it.  Why would anyone prefer to own stock and suddenly have downside risk.

 

If you are assigned an exercise notice on a call option prior to expiration, consider it to be a gift (unless you cannot meet the margin call).

 

2) If I no longer want to own the option, I sell it.  You seem to arbitrarily hold options until Wed/Thur of expiration week.  That is terribly foolish.  The ideal time to sell an option is when YOU no longer want to own it – not on an arbitrary calendar date.

 

3) The price paid for the option is 100% irrelevant.  I don't know why so many people get hung up on this.  Assume you own a call option and the price is $6.  Assume you no longer believe the stock is moving higher.  Does the price paid for that option change the decision to sell?  Would you sell if the cost were $2 but hold if you paid $7?  If 'yes,' then you don't understand trading. 

 

When you no longer want to own a position then don't own it.  Do not hold just because it would result in a loss if you were to sell.  You already lost the money, and holding invites a larger loss.

 

Bottom line: You either want to exercise your option, or you don't.  You either want to sell your option, or you don't.  The price you paid is ancient history and 100% immaterial.

 

4) If the time value is negligible, then there is no theta to be 'eroding fast.'  Theta is the erosion of time value.

 

5) I would never change my mind.  Period.  Exercising a call option is stupid (exceptions noted above).  Just take that as gospel.  It is stupid.  Just sell it when you don't want to own it.  Interest rates do not matter over a two-day period.  But why own stock for two days?  Don't exercise.

 

6) If the option bid is less than parity (i.e. if you cannot get at least a fair price for the option), then it is possible to exercise and IMMEDIATELY sell stock.  But this involves extra commissions and is probably still a bad idea.

 

It is NOT the bid/ask spread that matters.  If the stock is 60 bid, you can sell stock at 60.  If you own the 50-call and the market is 10 bid 14 asked, what difference does that make to you if the market is wide.  If you can sell at 10, that is easier and less expensive than selling stock.

 

If however, the market is 9.90 to 10.10, that's a nice tight market, but does you no good.  You want to sell the call at $10.  So yes, in this example, you may exercise and immediately sell stock.

 

Exercising calls to own the shares is a trade made by someone who should not be trading options.  One more point – if you were to make the mistake of exercising early, why would you do it in the morning?  Wait until the close of trading.  It is possible that the stock will decline 20 points that day and you would be left holding the bag.  Exercise instructions are irrevocable.

 

Related articles:

Want to learn more?

 

Start Your Free Trial

 

    What Is SteadyOptions?

    Full Trading Plan

    Complete Portfolio Approach

    Diversified Options Strategies

    Exclusive Community Forum

    Steady And Consistent Gains

    High Quality Education

    Risk Management, Portfolio Size

    Performance based on real fills

    Try It Free

    Non-directional Options Strategies

    10-15 trade Ideas Per Month

    Targets 5-7% Monthly Net Return

    Visit our Education Center

    Recent Articles

    Articles

    • Holiday Effect in VIX Futures

      With fewer trading days and a historical record that favors an uptick in stocks and a downtick in volatility, the end of the year never fails to present an intriguing set of trading opportunities. One phenomenon related to the above is something I have labeled the “holiday effect". 

       

      By Bill Luby,

      • 0 comments
      • 19 views
    • Fatal Flaws in Black-Scholes

      Is the Black-Scholes pricing model of options accurate? Or even close to accurate? A very interesting study conducted by Sibson Consulting was cited in an article on the topic (Tim Reason, “The Holes in Black-Scholes,” CFO Magazine, March 1, 2003).

      By Michael C. Thomsett,

      • 0 comments
      • 567 views
    • The Hidden Dangers of Iron Condors

      Ever seen those ads about making 5% per month with Iron Condors? It’s certainly possible, but you would have to be a bit naïve to think making a 60% per year return is simple. Most professional money managers cannot achieve those returns, so why would a retail trader be able to achieve it?

      By GavinMcMaster,

      • 2 comments
      • 720 views
    • Assignment and Exercise: The Mental Block

      Assignment and Exercise are among the most basic aspects of options trading that every options trader should understand. In this post I painstakingly explain one of the most basic option basics to a reader who is having trouble understanding that concept.

      By MarkWolfinger,

      • 0 comments
      • 192 views
    • 4 Levels of Trading Experience

      I would like to share with you another aspect of trading- my fascination with the different levels of trading experience. Starting in one of the latest discussions in the comments section, I shared with one of you that experience in trading comes in stages. I call those the 4 Levels of Trading.

      By Colibri Trader,

      • 0 comments
      • 841 views
    • The Spectacular Fall of LJM Preservation and Growth

      Investors of LJM Preservation and Growth Fund, a $772 million alternative mutual fund, got an email on Tuesday February 6, 2018: "LJM strategies have suffered significant losses." The fund (ticker: LJMAX) didn’t report the loss until late the following day, so shareholders were in the dark as to what happened.

      By Kim,

      • 0 comments
      • 483 views
    • 40 Steps In The Trader’s Journey

      It is a well known fact that most retails traders/investors lose money in the stock market. There are many explanations for that phenomenon. Trading is a journey, and not everyone is willing to complete it. Many quit too early. Here are 40 steps in the trader’s journey from new trader to rich trader. They are as follows:

      By SJosephBurns,

      • 0 comments
      • 1,109 views
    • 10 Things You Should Know About VIX

      The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE).VIX is considered by many a "Fear Index".

      By Bill Luby,

      • 2 comments
      • 1,775 views
    • How Does SVXY Work?

      There are many more ways to trade volatility today than there was prior to the financial crisis. Numerous ETF’s and ETN’s have been created as a way for traders to hedge volatility risk or gain exposure to it. Some of these are leveraged 2 and 3 times. To say they can be risky would be an understatement.

      By GavinMcMaster,

      • 0 comments
      • 2,106 views
    • 50 of the Top Trading Quotes Ever

      While trading quotes can be taken out of context, and it is crucial to have a full understanding of what the trader meant at the time, they can also give traders important insights.  I asked some of my followers for their favorite trading quotes. There were a lot of great suggestions, but here are the top 50 that I’d like to share.

      By SJosephBurns,

      • 0 comments
      • 985 views

      Report Article

    We want to hear from you!


    There are no comments to display.



    Your content will need to be approved by a moderator

    Guest
    You are commenting as a guest. If you have an account, please sign in.
    Add a comment...

    ×   Pasted as rich text.   Paste as plain text instead

      Only 75 emoticons maximum are allowed.

    ×   Your link has been automatically embedded.   Display as a link instead

    ×   Your previous content has been restored.   Clear editor

    ×   You cannot paste images directly. Upload or insert images from URL.

    Loading...

    Options Trading Blogs