"Sell or Exercise Expiring Call Options?"

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"Sell or Exercise My Expiring Call Options?"

"I bought a call OTM with a strike price of $29. That same option is now ITM. It expires in a few days. How do I determine if it's more worth it for me to sell that option now, or excerise it and get the underlying stock?"
- Asked By Jean-Claude on 11 July 2013

Answered by Mr. OppiE

Hi Monica,

Congratulations on a profitable long call options trade!

Holding an option from OTM all the way until it gets ITM is the most direct and most profitable way of trading options. In almost all of such cases, it is always more profitable to simply sell the options and take profit instead of exercising for the underlying stock.

This is because exercising for the underlying stock requires extra commission for the buying of the underlying stock and then more commissions for selling them in the open market for the profit. Not only are you paying more commissions if you exercise for the underlying stock just to sell them in the market for profit, you are also sacrificing what little extrinsic value is left in your call options, thereby lowering profitability even if commissions are not taken into consideration.

To Sell or Exercise Call Options Example Assuming you bought 5 contracts of XYZ's July $29 call options when XYZ was trading at $30 for $1.20 (total of $1.20 x 500 = $600), expecting XYZ to continue going upwards. XYZ moved to $31 by one week to expiration of the July options and the July $29 Call Options you bought are now worth $2.05. Assuming options commissions for 5 contracts of options trade is $8 and stock trading commission is $0.01 per share. If you simply sell the options, you make: $2.05 - $1.20 = $0.85 x 500 = $425 - $8 = $417 If you exercise for the underlying stock, you make: $31 - $29 = $2 x 500 = $1000 - $600 = $400 - (($0.01 x 500) x 2) = $400 - $10 = $390 (Shares commission is multiplied by 2 due to buying and then selling the shares for the profit)

In the example above, it is clearly more advantageous to just sell to close the call options and take profit rather than exercising for the underlying stock due to the fact that you are sacrificing $2.05 - $2.00 = $0.05 worth of extrinsic value in the call options and paying $10 - $8 = $2 more commissions for buying and selling the stock.

However, if the overall commissions for buying and selling the stock is actually cheaper than the commissions involved in selling the options and the loss in extrinsic value added up, it would actually be more advantageous to exercise for the underlying stock.

To Sell or Exercise Call Options Example 2 Assuming you bought 5 contracts of XYZ's July $29 call options when XYZ was trading at $30 for $1.20 (total of $1.20 x 500 = $600), expecting XYZ to continue going upwards. XYZ moved to $31 by one week to expiration of the July options and the July $29 Call Options you bought are now worth $2.01. Assuming options commissions for 5 contracts of options trade is $18 and stock trading commission is $0.01 per share. If you simply sell the options, you make: $2.01 - $1.20 = $0.81 x 500 = $405 - $18 = $387 If you exercise for the underlying stock, you make: $31 - $29 = $2 x 500 = $1000 - $600 = $400 - (($0.01 x 500) x 2) = $400 - $10 = $390 (Shares commission is multiplied by 2 due to buying and then selling the shares for the profit)

In the example above, exercising for the stocks and then selling the stocks in the open market actually makes $3 more profit than selling the call options directly due to the extremely low ($0.01) extrinsic value remaining in the call options and the ridiculously high options trade commission.

There is one more scenario in which exercising for the underlying stock results in more profit than selling the call options and that is if the underlying stock is going ex-dividend and the dividend receivable (less tax) is higher than the loss of extrinsic value and commissions added together. However, doing so exposes you to directional risk of holding on to the stocks which may actually move lower during the holding period, resulting in loss of profit or worse, a loss. Also, stocks usually drop in the amount of dividends declared on the day of declaration itself, as such, even though you might profit from the dividend, you will usually be making an offsetting loss on the stocks you are holding, thereby negating the profit. Also, you won't usually know how much dividends are going to be declared until it is declared, as such, deciding to exercise for the underlying stock before ex-dividend is more of a gamble.

Another more obvious issue of wanting to exercise for the underlying stock is that you need to have enough cash in your account to buy the underlying stock in the first place. If you don't, then selling your call options for profit is the only thing you can do.

In conclusion, there are very few reasons for wanting to exercise for the underlying stock when you are holding a profitable options position. Even in the extreme case of high options commissions and very low extrinsic value remaining, most options traders would still prefer to just sell their options rather than risk slippage losses going through the whole process of exercising for the underlying stock and then selling the stock in the market for that little bit of extra potential profit.