Options contracts provide traders with the right (but not the obligation) to buy or sell an underlying asset at a predetermined price and date. Exercising an options contract refers to the act of executing that right to either buy or sell the underlying stock.
What is Exercising an Options Contract?
Exercising an options contract is the process of buying or selling the underlying asset at the predetermined price agreed upon when the contract was initially purchased. If an options contract is exercised, the seller of the contract is obligated to sell or buy the underlying asset.
- Exercising a call option allows you to buy the underlying stock at the strike price.
- Exercising a put option allows you to sell the underlying stock at the strike price.
Exercising a Call Option
Exercising a call option means that the investor decides to buy the underlying asset at the strike price. For example, let’s say you purchase a 50-strike call on XYZ stock – paying $2 in premium.
If the current market price of XYZ stock is $60 per share at the expiration date, you could exercise the option and buy 100 shares of XYZ stock for $50 per share. You could then immediately sell them at the market price of $60 per share, realizing a profit of $8 per share, or $800 in total ($1,000 – $200).
However, if the current market price of XYZ stock is below the strike price at expiration, the contract would be considered out-of-the-money. In this case, you would let the option expire worthless and lose only the premium paid for the call option.
Exercising a Put Option
Exercising a put option means that the investor decides to sell the underlying asset at the strike price. For example, let’s say you purchased a 45-strike put on ABC stock – paying $1.50 in premium.
If ABC stock is $40 per share at expiration, you could exercise the put option and sell 100 shares of ABC stock for $45 per share. You could then immediately buy them at the market price of $40 per share, realizing a profit of $3.50 per share, or $350 in total ($500 – $350).
On the other hand, if ABC stock is above the strike price at the expiration, the option would expire out-of-the-money. In this case, you would let the option expire worthless, and lose only the total premium paid for the put.
How to Exercise an Options Contract?
The method of exercising an option will depend on your individual broker. However, most offer the ability to do this yourself but some do require you to contact them directly.
When exercising a call option, you will need to have enough funds in your account to purchase the underlying asset at the strike price. When exercising a put option, you will need to have the underlying asset available to sell at the strike price.
Once you’ve provided your broker with the necessary instructions, they’ll take care of the rest.
Option Exercise FAQs
Exercising an options contract means buying or selling the underlying asset at the predetermined price and date agreed upon when the contract was initially purchased. It is the act of executing the right to either buy or sell the underlying stock.
Yes, you can exercise an option contract before the expiration date. However, early exercise is not always the most profitable option.
If you choose not to exercise your option contract, it will expire worthless at the expiration date. You will not be able to buy or sell the underlying asset at the predetermined price specified in the contract.
Yes, you can sell your option contract before it expires in a process called selling to close. This allows you to realize any gains or losses from the contract without actually exercising it.
