Today, we’re going to look at the process of how to exercise a call option. We’ll look at the actual process of exercising a call option, why a trader would exercise and what happens afterwards.
Let’s get started.
Contents
- Introduction
- The Process of Exercising The Option
- After Exercising the Assignment
- Why Exercise an Option
Introduction
Let’s look at the process of exercising a call option.
If you buy a call option on a stock, you can “exercise” your right at any time you own the option.
“Exercise” means you have the right to buy the stock.
The person who sold the call to you is “assigned an obligation” to fulfill the terms of the option contract to sell the stock.
The Process of Exercising The Option
The trade is quite simple to set up.
The OCC, the Options Clearing Corporation, controls all exercises and assignments after the trades are made.
Example: Let’s say you buy an XYZ June 50 call option.
The stock rises in price to $55 per share and you decide to exercise your right to buy the stock for a profit. You instruct your broker to do so.
The broker notifies his administrative staff to exercise and buy the stock.
The order is then sent to the OCC: exercise one contract of the June 50 call series.
The OCC randomly selects a firm who is short the XYZ June 50 call.
The firm must deliver 100 shares of XYZ at $50 per share to the firm that exercised the option. The firm contacts the client of their obligation.
The selection process is:
- First-in/first-out basis or
- Randomly
After Exercising the Assignment
The OCC and the customer exercising the option usually do not care the way the method of delivery is executed.
They want to make sure that 100 shares of XYZ at $50 are delivered.
The holder who exercised the call can keep the stock in their account if they want to, but must pay cash or margin it fully.
Or the holder may want to sell it in the open market for a price higher than $50.
If the holder has a margin account it may be sold immediately.
If the holder exercises in a cash account, the stock must be paid in full; even if sold that day. Check with your broker.
Why Exercise an Option
There are a few reasons why you might choose to exercise your option:
- To own the stock. If you are bullish and you own calls on the underlying stock, you may want to exercise the options contract to own the stock. Presumably, the stock price has risen and you can lock in a profit.
- To get the dividend. The time value may be less than the dividend payable to the owner of the underlying security.
- To help offset a short/long position. You might use options to offset losses from an existing position.
Note: There will be fees and commissions charged to you and closing out an options position triggers a taxable event, so consider the tax implications.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
