How to Decide Whether to Exercise a Call Option
Original post by Leslie McClintock of Demand Media
A call option is an option to purchase a security at a specific price. These options are bought and sold over stock exchanges just like securities. Investors seeking to eke out a few dollars of extra income will frequently sell call options, while investors may buy a call option in order to protect themselves against an unexpected price move in a specific security, or to gain exposure to large potential gains while putting up a very small amount of capital. Options are good only for a limited period of time, however. At the end of the time period, your options will expire worthless, regardless of the price of the underlying stock.
Determine the current market value of the security. You can do this by going to a market news portal, such as an investing website or a major newspaper's website. You can also look up the previous day's closing prices in the financial pages of many major newspapers.
Compare the current price of the security with the "strike price" of the call option. This is the price at which the seller of the call option has promised he will sell the security to you. You can find the strike price on your option contract. In the case of employer-granted stock options, your human resources department can point out the strike price and expiration data for you.
Exercise the option if the current market price of the security is higher than the strike price of the call option. This means the option is "in the money." You may be able to sell the security right away after buying it, resulting in an immediate profit. In some cases, however, the market for a given security may be illiquid, and you may have difficulty finding a willing buyer. It can also be difficult to sell quickly during periods of rapid decline, as a security's price can "gap" downward very quickly if there is a lot of selling pressure in the market. Do not exercise the option if the strike price on the call option is higher than the market value of the security.
Tips & Warnings
- You may be able to sell the option, rather than exercise it - especially if the option is "in the money." This may save you brokerage fees, since you would have to pay a commission to a broker to purchase the securities. You also may wish to sell the option, rather than exercise it, if you don't have the cash to purchase the security outright.
- StockTradingToGo.com: 5 Reasons Not to Exercise Call Options
- Options Industry Council: Puts and Calls
About the Author
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.