Five Reasons Not to Exercise a Call Option

The average individual investor should probably never exercise an option. There are a couple of exceptions, but if you are someone who buys options, these probably do not apply to you. I recommend selling the options any time you want to exit the trade.

There are good reasons for not exercising.

1) Paying Fees. Most brokers charge a relatively high fee to exercise. If you then sell the shares you just bought, you must pay another commission. What was the point of exercising? Just sell the option.

2) Paying Interest. When you exercise a call option, you take possession of the shares. That means you must pay for the shares, using cash. If you don’t have the cash on hand, you must borrow it from your broker. In either case, you pay interest to use cash. Current interest rates are low, but they will not always be low. This is a waste of money.

3) Risk of Loss. This is a real danger when you exercise an option prior to expiration, and is something that many investors fail to recognize. If you own a call option and the stock plunges, your loss is limited to the value of the option. But, if you converted your calls to stock, your loss becomes essentially unlimited when the stock declines rapidly.

4) Weekend risk. Some investors exercise the options when expiration arrives, planning on unloading the shares when the market opens the following Monday. This involves an unnecessary risk. Stocks do not always behave as expected and occasionally gap open at a price that differs from the previous day’s closing price. Why take that chance? Sure, the price may be higher and you reap an extra profit. But it’s a gamble. If you plan to sell the shares, don’t exercise. Just sell your calls before the market closes Friday.

5) Nothing to Gain. Each of the problems listed above occurs when you exercise an option. It may pay to accept those costs or risk, if there were something to gain. But exercising the stock and holding it gives you all the risks of a stockholder, with no benefits. If you want to maintain a long position in the same stock, sell your old option and buy another option with a later expiration date.

Mark Wolfinger is a 20 year CBOE options veteran and is the writer for the blog Options for Rookies Premium. He also is the author of the book, The Rookie's Guide to Options.

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Comments

  1. Posted by Nath on October 22, 2009 at 4:14 pm

    I think the hardest part, honestly, is staying with what you decided- to stay with a trade and not second guess yourself like we often do…I hate trying to predict things, but I often fall victim to exactly what this post is talking about: Why Are We Such Suckers For Prediction

  2. Posted by Mark Wolfinger on October 22, 2009 at 4:19 pm

    I don't consider it to be second-guessing when a position has become too risky to hold or when the reason you mad the original trade is no longer valid.

    I believe it is far worse to bury your head in the sand and pretend all is well.

    Unless you adopt passive investing (index funds) you must make decisions and they cannot all be winners.

  3. Posted by David on November 18, 2009 at 3:56 pm

    Why not sell (not short) the shares first, then exercise the option? You've got three days to deliver the shares. As long as you exercise the option on the same day, you would have the shares for settlement.

  4. Posted by Mark Wolfinger on November 18, 2009 at 4:03 pm

    Selling short first is better than exercising first. Agreed.

    But there is no need to do either when you can sell option.

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