Tag Archives | option exercise

When not to exercise a call option

I generally take the approach that there is no such thing as a dumb question.  If you don't understand something, there's a good chance that others will also be in a quandary over the identical question.  However, I am reconsidering.  The second question below – and I have seen it many times – is truly a dumb question.

 

Mark,

Thanks for revisiting this topic.

What if I want to buy and sell calls but don't want to sell my current shares. Is there anyway to avoid this?

If I am selling covered calls, and the stock hits the strike price, isn't it almost a given that the stock will be called away from me and sold at the strike price?

Mike

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To Mike,

1) Yes, there is a way to avoid selling the stock. One simple method is to hold the long stock shares in a different account.
Then if you are assigned an exercise notice you will still own the shares in one account and be short shares in the other account. You can repurchase those short shares whenever you want to do so and remain long the original shares
2) Of all the questions that I receive – and I appreciate each and every one of them – this specifc questions bothers me more than any other.  I get it repeatedly and cannot understand how that is possible. 
Warning: Anyone who asks this question should not be trading options.  Not now, and possibly not ever.
The most basic concepts of using options involves some consideration of how options are priced and what they are worth.  No one in his or her right mind would ever – and I mean ever – exercise a call option just because the stock 'hits the strike price.'
There are so many reasons why this is true that it painful to attempt to list them. Here are two.
a) Your question assumes that writers of call options only sell options that are out of the money.  Let me assure you that many traders sell options that are already in the money – and that means the stock has hit the strike price – even before the option was sold.
I, for one, would never write an out of the money covered call, preferring to always take the more conservative path of writing in the money call options. let me assure you that I have never been assigned the day I sold the options, even though the stock has already 'hit the strike price.'
Virtual guarantee

b) If the stock hits the strike price, it's almost a 100% guarantee that your option will NOT be exercised under those circumstances.
Do you want proof? Look at any stock that is above the strike price of a given call option.
For example, yesterday AAPL closed at $309.52. 
Look at the open interest for Nov 300 calls.  Is it zero?  Did everyone who was long that option exercise it when AAPL passed $300 on the way up?
Look at AAPL Nov 290 calls. Is the open interest zero?  Did everyone exercise his/her long AAPL Nov 290 calls when the stock moved past that price?
Is that open interest anywhere near zero? Does it look as if everyone who was long that option exercised?
Now kook at the price of the Nov 300 call.  If the call owner exercises he owns AAPL at $300 per share when it's trading $9.52 higher. Exercise and your call becomes worth $952.
Do you see that the call closed trading yesterday near $19?  If you sell that call, you collect $1,900.  Would you prefer to have $952 or $1,900?
Isn't it price far above the option's intrinsic value? Don't you understand that if the option were exercised the owner would lose every penny of that time premium?
If you do not understand every word of the explanation above you have no business trading options. You have no idea how options work and have zero chance – outside of good luck – to earn any money.
Learn the basics. Then trade.
3) I ask a favor: Where did you get the idea that the option would be exercised under the conditions stated? Please write again and tell me who is teaching people that this absurdity is within the realm of possibility.
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Exercise and Assignment. Not to worry

The exercise/assignment process is straightforward, easy to understand, and is experienced by almost every option trader at one time or another. 

An option is a contract in which the writer (seller) promises that any buyer has the right  to buy or sell the underlying asset at the strike price on or before a specific date.

Electing to buy or sell the underlying (per the contract) is referred to as 'exercising.'  Being notified that the exercise has been assigned to your account is referred to as an 'assignment.'

Unfortunately, many new traders become overly worried about the process because they  don't bother to pay attention to the rules regarding how the process works. Why would anyone trade an option without being aware that it's possible to be assigned early?  When we drive a car, we are supposed to learn the rules of the road.  Traders who don't take the time to understand what they are trading are flying blind.

I've discussed this topic many times (here's the first), and you can search (below) for Exercise and assignment to read some of the posts.


Free put, free call

Why beginner's fear being assigned an exercise notice is beyond my comprehension.   When anyone sells an option, he/she is accepting an obligation to be assigned.  So why is it it so unsettling to be assigned one of those exercise notices prior to expiration?

Being assigned an exercise notice turns a short call option into short stock.  So what?  That exercise is equivalent to giving the option seller a free put [same strike and same expiration as the option being assigned].

Being assigned an exercise notice on a put option does cost a bit of cash (in carrying costs), but it is equivalent to being given a free call.

It's unlikely that these free options will be worth anything, but every once in awhile lightning strikes and I love  being handed those free puts and calls.  Unless it results in a margin call, being assigned early is not a problem.  If it does result in a margin call, you are probably trading too many contracts for the size of your account.

 

European and American style options

European style options cannot be exercised prior to expiration.  If you absolutely cannot tolerate being assigned early, it may pay to trade European style options.  However, there are far more important items that differ between American and European style options that it's crucial to understand these differences before attempting to trade them.  this is not an idle warning.

To read more about these differences, search (below) for American vs. European options

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