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. An options holder may exercise their right to buy or sell the contract's underlying shares at a specified price—also called the strike price.
To exercise an option, you simply advise your broker that you wish to exercise the option in your contract. Your broker will initiate an exercise notice , which informs the seller or writer of the contract that you are exercising the option. The seller is obligated to fulfill the terms of an options contract if the holder exercises the contract.
The decision to exercise an option isn't always a clear-cut one. There are several factors that need to be considered and, more often than not, it's safer to hold or sell the option instead. 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. In addition, the holder loses the premium they paid for the option, along with any commissions and fees related to its purchase. Advanced Options Trading Concepts. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.
The Option Exercise window will appear and any long options you are holding will populate under the Long Positions column header. Your Exercise request will now show as an order line on your Trader Workstation until the clearinghouse processes the request. If the option is out-of-the-money, a warning message will appear. 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. 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.
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. 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. 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. 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. Verify the net result. When your options have been exercised, your broker will deposit your profits less fees and commissions into your account. For a put option, you'll have a cash deposit. For a call option, you'll have shares in the underlying stock.
If you exercised a call option, the commissions and fees will come out of the cash in your account, not from selling the shares of stock you purchased through your options contracts. Method 2. Evaluate the risk in your options position.
Trading options is inherently risky, but offsetting options can minimize the risk involved.
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