Can You Exercise a Call Option Early?

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An option gives you the right to buy or sell 100 shares at a designated strike price. Some traders purchase calls with good timing. These traders watch as the stock’s price soars and their calls gain value. While many traders exit their calls before expiration, some options traders want to receive 100 shares from their calls. It’s common to wait until the expiration date, but you can exercise an American call option early (this is not the case for European call options). Sometimes, it’s beneficial to go that route instead of waiting until expiration.

Understanding Exercise and Assignment in Options Trading

Every in-the-money option at expiration gets exercised or assigned, but your status depends on the options contract you have. An exercise occurs when someone holding onto a long call wants to buy 100 shares at the strike price. A trader exercising a put would sell 100 shares at the contract’s strike price.

Any exercised option triggers an option assignment. The person who shorted the option must fulfill the contractual obligation and accept the assignment. If an option holder exercises a long call, the trader who shorted the option must sell 100 shares to the option holder at the agreed-upon strike price. 

The person holding the option can exercise it at any moment. The trader who shorted the option must wait for the contract to get assigned before having to buy or sell 100 shares, depending on the type of option.

What Is the Difference Between Selling to close a Call Option and Exercising It Early?

Selling to close a call option involves exiting the position without shares, and it’s common for people who do not have enough money to exercise the option. If you buy a call with a 500 strike price, you would need $50,000 sitting in your account to exercise the contract and acquire 100 shares. Traders without $50,000 to spare may sell the call option assuming it has gained in value. Just like selling a stock, you leave the position by selling your long call.

When you exercise a call option early, you are essentially buying the underlying stock at the strike price. This means that you are taking ownership of the stock and will be responsible for any future price movement.  If the stock price goes up after you exercise the option, you can make money on the difference between the stock price and the strike price. Someone who sold a call option has already exited the position and does not have any exposure to the stock price risk. 

How Does Exercising a Call Option Early Work?

Brokers will automatically exercise an in-the-money call option at expiration, but you will have to contact your broker about exercising a call option early. Brokers typically respond promptly and enable you to exercise the option early. The person with the short position will get assigned and have to provide the 100 shares for the call. The process runs smoothly once you tell your broker that you want to exercise an option early.

When Does It Make It Sense to Exercise a Call Option Early?

Exercising a call option early may be advantageous when the option is in-the-money and approaching expiration. It may seem like a foregone conclusion that the option will end up in the money at expiration, and an early exercise may result in several advantages. Exercising early can potentially result in additional gains that will be discussed shortly. 

Example of Exercising Early

Let’s consider a scenario where a trader purchases a call option with a $100 strike price that expires in three months. In this example, the stock was trading at $90 per shares. However, overtime the stock’s price rises significantly $120 per share, resulting the option being deep in the money (ITM).  With 4 days left until the option’s expiration date, the trader decides to exercise the option early when the stock is priced at $120 per share. The trader then receives the 100 shares at the agreed-upon strike price of $100 per share. After early exercise, the trader has the flexibility to hold onto the shares long after the expiration date.

Potential Benefits of Exercising Early

While you can exercise an ITM option early, most people let the brokers handle it automatically at expiration. You end up with the 100 shares anyway, so why do some people exercise options early? An early exercise can present several benefits.

1. Receiving Dividend Payments

If the underlying stock pays a dividend, you will not receive dividends while holding onto the option. Corporations decide who gets dividends based on the record date. You have to own shares before the ex-dividend date to qualify for the dividend. If the option expires after the ex-dividend date, some traders will exercise the option early to have the 100 shares before the ex-dividend date. The trader will obtain the shares anyway, so they might as well get the dividend too.

2. Follow Up with a Covered Call

When you exercise a call, you receive 100 shares. Some investors sell covered calls after acquiring 100 shares. If you believe the stock is overvalued in the short run, you can exercise the option early and then use this options trading strategy to further reduce your cost basis. If you buy a call with a $100 strike price, it will exercise at expiration regardless of whether the stock is valued at $120 per share or $105 per share. If the stock is $120 per share, and you believe it will fall to $105 per share, it may make sense to exercise the call early and then sell a covered call.

3. The Ability to Sell Shares at an Elevated Price

Not everyone wants to hold onto 100 shares. Some traders exercise a call option and proceed to sell some of the 100 shares. Trimming the position can improve portfolio diversification and let you use the funds to buy other stocks. You can’t trade fractional options, so it may make sense to exercise the option early and then sell some of the shares. You can also consider exercising shares early before the end of the year if you have enough capital losses to absorb the profits. You should contact your tax advisor before considering any tax-loss harvesting strategies. 

Limitations of Early Exercise

Exercising an option early may have potential advantages, but it isn’t for everyone. These are some of the limitations of exercising options early.

1. European Options Cannot Get Exercised Early

Pros and cons aside, if you have a European option, you cannot exercise it early. These options get exercised if in-the-money on the expiration date, but you can sell a European call option to exit the position.

2. You Need Enough Funds to Exercise an Option

An option trader who bought a call with a $300 strike price needs $30,000 in cash to exercise the option not including any additional fees.  If you do not have enough cash, you won’t be able to exercise the option early.

3. The Option Must be in the Money

You cannot exercise an option that is out of the money. It wouldn’t make sense to buy 100 shares at a $110 strike price when you can buy them for $100 in the stock market. 

If you exercise an ITM option well before expiration, you may forfeit the extrinsic value of the contract. For example, let’s say you buy an ITM call option with a strike price of $100 and the stock price is currently $110. At this juncture, the option holds an intrinsic value of $10 ($110-$100) leaving an extrinsic value of $5, and the combined premium would amount to $15. 

If you choose to exercise the option immediately, you will pay $100 per share for the stock, even though you could buy the stock for $110 in the market. This means that you are forfeiting the $5.

Navigating Early Exercises

Most options do not get exercised early, but getting your shares before the expiration date has its benefits. The closer you get to the expiration date, the more it can make sense to exercise your contract. Investors should consider their use of the 100 shares and monitor upcoming events related to the company before deciding to exercise call options early. 

Frequently Asked Questions

Disclosures: Options trading entails significant risk and is not appropriate for all customers. It is important that investors read Characteristics and Risks of Standardized Options (https://j.us.moomoo.com/00xBBz) before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount. Supporting documentation for any claims, if applicable, will be furnished upon request. 

Benzinga was commissioned for this article and is not affiliated with the moomoo app or it’s affiliated companies. This includes Moomoo Technologies Inc. (MTI) provider of the app and Moomoo Financial Inc. (MFI) Member FINRA/SIPC, which offers securities in the U.S. Any comments or opinions provided herein are Benzinga’s. MTI, MFI, or their affiliates do not endorse any trading strategies that may be discussed or promoted herein. Moomoo and its affiliates make no representation or warranty as to the article’s adequacy, completeness, accuracy or timeliness for any particular purpose of the above content.

The post Can You Exercise a Call Option Early? by Marc Guberti appeared first on Benzinga. Visit Benzinga to get more great content like this.