when to exercise early
in many instances holders of american style options do not utilize the early exercise provision since it s usually more cost effective to either hold the contract until expiration or exit the position by selling the option contract outright in other words as a stock price rises the value of a call option increases as does its premium traders can sell an option back to the options market if the current premium is higher than the initial premium paid at the onset the trader would earn the net difference between the two premiums minus any fees or commissions from the broker however there are times when options are typically exercised early deep in the money call options where the asset s price is well above the option s strike price will usually be exercised early puts can also be deep in the money when the price is significantly below the strike price in most cases deep prices are those that are more than 10 in the money with lower priced equities deep in the money might be characterized as a 5 spread between the strike price and market price early execution can also happen leading up to the date a stock goes ex dividend the cutoff date by which shareholders must own the stock to receive the next scheduled dividend payment option holders do not receive dividend payments so many investors will exercise their options before the ex dividend date to capture the gains from a profitable position and get paid the dividend advantages and disadvantages of american optionsamerican options are helpful since investors don t have to wait to exercise the option when the asset s price rises above the strike price however american style options carry a premium an upfront cost that investors pay and which must be factored into the overall profitability of the trade allows exercise at any timeallows exercise before an ex dividend dateallows profits to be put back to workcharges a higher premiumnot available for index option contractsmay miss out on additional option appreciationexamples of an american optionsay an investor purchased an american style call option for apple inc aapl in march with an expiration date at the end of december in the same year the premium is 5 per option contract one contract is 100 shares 5 x 100 500 and the strike price on the option is 100 following the purchase the stock price rose to 150 per share the investor exercises the call option on apple before expiration buying 100 shares of apple for 100 per share in other words the investor would be long 100 shares of apple at the 100 strike price the investor immediately sells the shares for the current market price of 150 and pockets the 50 per share profit the investor earned 5 000 in total minus the premium of 500 for buying the option and any broker commission let s say an investor believes shares of meta inc meta formerly facebook will decline in the upcoming months the investor purchases an american style july put option in january which expires in september of the same year the option premium is 3 per contract 100 x 3 300 and the strike price is 150 meta s stock price falls to 90 per share and the investor exercises the put option and is short 100 shares of meta at the 150 strike price the transaction effectively has the investor buying 100 shares of meta at the current 90 price and immediately selling those shares at the 150 strike price however in practice the net difference is settled and the investor earns a 60 profit on the option contract which equates to 6 000 minus the premium of 300 and any broker commissions investopedia does not provide tax investment or financial services and advice the information is presented without consideration of the investment objectives risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors investing involves risk including the possible loss of principal 