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Introduction:

In this essential guide to stock option exercise, we explain the main concepts an investor or employee might consider before exercising the right to exercise an option contract. Remember that the speculative aspect of options, which involves purchasing and selling stock options, is the focus of this article.

What are Stock Options?

A stock option is a contract that gives the holder the right, but not the obligation, to buy or sell shares of a stock at a predetermined price (the \”strike price\”) for a specified period of time. Stock options are used as a form of compensation, as well as a way for companies to raise capital and for investors to speculate on the future direction of a stock\’s price. The holder of a call option has the right to buy the underlying stock at the strike price, while the holder of a put option has the right to sell the underlying stock at the strike price.

However, keeping things simple is the way to go. Our philosophy at Unison Finance is to follow the concept known as \”KISS,\” or keep it stupid simple, as trading options does not need to be complicated.

If you are new to trading options or exercising options, you have come to the right place. The following guide will cover all the essential information about exercise options.

Put Options Vs Call Options

Long Put:

Enable us to sell shares of the underlying stock at the strike price before or on the expiration date.

Note: If we hold a long put option, we are not obligated to exercise it. It would only should be done if it would result in a profit for us.

Short Put:

If we exercise our right as the owner of a long put option, the person who sold (or wrote the short put) the short put contract is obligated to purchase the underlying shares at the agreed strike price. Therefore, even though we are not required to exercise our right, the option writer will have to buy our shares if we do.

Note: Long put options are considered to be trading ITM (in the money) when the stock price is trading lower than the strike price.

Long Call:

A long call gives us the right to buy the underlying stock at pre-determined strike price. It is a bullish and an investor/trader may purchase a call option in the anticipation that the value of the underlying asset will rise. The option holder can sell the option for a profit if the price does rise.

Short Call:

On the other hand, a \”short call\” option is a bearish strategy in which an investor sells a call option in an effort to make money from a decline/sideways price action in the value of the underlying asset.

If the call option buyer chooses to exercise their option, the call option seller is obligated to sell the underlying asset to them at the agreed-upon strike price. As a result, the seller of the call option may sustain substantial losses if the value of the underlying asset rises because they will be forced to sell it below market value.

Note: A long call option contract is known to be trading ITM (in the money) when the stock price is trading above the strike price.

Long Vs Short Options

Long Option:

When the stock price is trading above the strike price of the long call option or below the strike price of the long put option, both options will be trading in the money (ITM) and both long call and long put holders will profit.

Short Options:

When the stock price is trading below the strike price of the short call option or above the strike price of the short put option, both options will be trading out the money (OTM) and both short call and short put sellers will profit

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Option exercise process

Instead of letting the contract expire worthless or closing out the position, the owner of an option will be \”exercising the option,\” or using the right or privilege granted by the contract, if they choose to buy or sell the underlying instrument at the pre-determined strike price.

The right to buy or sell the underlying shares of a contract may be exercised by an options holder at a predetermined price (also known as the strike price).

We can sell the underlying security by exercising a long put option at a predetermined price and within a predetermined window of time.

We can purchase the underlying security at a specified price within a specified timeframe by exercising a long call option.

We need only inform our broker that we want to exercise the option in our contract in order to exercise an option. In order to notify the seller or contract writer that we are exercising the option, our broker will start an exercise notice process. The Options Clearing Corporation transmits the notice to the option seller (OCC). If the option holder exercises the contract, the seller must adhere to the terms of the agreement.

What stock Options Exercise Mean?

Exercising a stock option means exercising the right to buy or sell a specific stock at a predetermined price (the strike price) during or before the expiration cycle of the option.

In other words, the holder of a stock option has the choice to buy or sell the underlying stock at the designated strike price, but is not obligated to do so. The holder effectively buys or sells the underlying stock at the strike price when they decide to exercise the option.

We will become a shareholder in the company if we choose to exercise our stock options. Owning stock options differs from directly owning shares.

When to exercise stock options

The choice to exercise stock options is a personal one that is influenced by a number of variables, such as:

The current stock price,
The option\’s strike price,
The investor\’s financial objectives
The option\’s expiration date.

Long Call Exercising:

If the current market price of the underlying stock is trading higher than the strike price of a long call option, an investor would typically exercise their long call stock options. With a profit, the investor is able to buy the stock at the lower strike price as opposed to the higher market price.

Long Put Exercising:

If the current market price of the underlying stock is trading lower than the strike price of a long put option, an investor would typically exercise their long put stock options. With a profit, the investor is able to sell the stock at the higher strike price as opposed to the lowermarket price.

When choosing whether to exercise stock options, there are still other things to take into account. For instance:

Expiration date: The period of time that a stock option can typically be exercised is known as its expiration date. It might not be worthwhile to exercise the option if it is about to expire and the market price is less than the strike price.

Financial objectives: The decision to exercise will also be influenced by the investor\’s financial objectives. The investor may exercise their options and sell the underlying stock right away if they want to make a quick profit. The investor may decide to wait and exercise the options at a later time if they intend to keep the stock for a long time.

Taxes: If the exercise results in a taxable event, the investor will be responsible for paying taxes on any profits made as a result of the exercise. Before deciding whether to exercise, it might be advantageous to think about the tax repercussions.

Note: In the end, the choice to exercise stock options should be made after careful evaluation of all pertinent factors and, if necessary, with the assistance of a financial advisor.

Extra things to consider before Exercising a Stock Options Contract?

The right time is crucial when exercising stock options. When determining the ideal time to exercise our stock options, there are a few things to keep in mind.

First: To start with, we should confirm our financial stability. To be eligible for the tax benefits that are offered to us, we do not want to invest more in stock options than is necessary.

Second: We should confirm that the business is financially sound. It might not be a good idea to exercise our stock options if the company is going through a rough patch.

Third: We should make sure that exercising our stock options would not put us at undue risk. Should the business file for bankruptcy, we do not want to lose everything we invested.

Fourth: Be certain that we are well versed in the stock of the business. We do not want to invest in stock that will depreciate.

Note: Additionally, we should have a solid plan for how we will use the stock once we have it. When is the best time to exercise our stock options? All of these variables should be taken into consideration. So, make a decision right away. It is best to start exploring our options as soon as possible.

YOU MAY ALSO BE INTERESTED IN READING AND LEARNING ABOUT OUR 5 CONCEPTS OF ANALYSING A BUSINESS TO TRADE STOCK AND STOCK OPTIONS

YOU MAY ALSO BE INTERESTED IN READING AND LEARNING ABOUT OUR 5 CONCEPTS OF ANALYZING A BUSINESS TO TRADE STOCK AND STOCK OPTIONS

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How to exercise stock options

Long Call Option Example:

Chart:

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Suppose the current share price for the ticker symbol XYZ is $50. We can buy a call option with a strike price of $55 and 30 days remaining to expiration in the hope that the stock will increase. The call option is out-of-the-money (OTM) when we open the position because the stock price is currently less than the option\’s strike price.

In this hypothetical example, the call option premium cost $1.00 per contract, but because one option contract is equal to 100 shares, the call option\’s total cost in this instance is $100.00.

In this example, we have the option (but not the obligation) to purchase 100 shares of the XYZ stock at the $55 strike price prior to the contract\’s expiration date.

1. Case Scenario:

Chart:

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The share price of Stock XYZ is $45 at the time of expiration. There is no reason to execute the call option contract and buy the shares at the $55 strike price in this scenario because the shares\’ value on the open stock market is considerably lower. If we let the option contract expire worthless in this situation, we will lose the premium we paid to open the position. No matter how far below the strike price the stock is currently trading, the same scenario applies.

2. Case Scenario:

Chart:

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The price per share of Stock XYZ is $55 or in other words at the money (ATM) at the time of expiration. Shares will be purchased at the strike price ($55) if the option is exercised, which is the same price as the stock represented by the open contract. The loss of the premium ($1.00 per share) paid to open the position results in a loss on the transaction.

3. Case Scenario:

Chart:

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The share price of Stock XYZ is $56 at the time of expiration. We can now buy the shares at $55 and immediately sell them on the open market for $56, making $1.00 profit per share. However, the expense of purchasing the call contract at $1 per share completely cancels out the profit.

4. Case Scenario:

Chart:

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The share price of Stock XYZ is $60 at the time of expiration. Now that the shares have reached the strike price of $55, we can buy them at that price and immediately sell them for $60 on the open market, earning $5.00 per share. The position\’s net profit equals $4.00 per share once the premium ($1.00 per share) paid to purchase the call option contract has been subtracted.

Long Put Option Example:

Chart:

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Suppose the current share price for the ticker symbol XYZ is $50. We can buy a put option with a strike price of $45 and 30 days remaining to expiration in the hope that the stock will increase. The put option is out-of-the-money (OTM) when we open the position because the stock price is currently more than the option\’s strike price.

In this hypothetical example, the put option premium cost $1.00 per contract, and as we saw in the put option examples above one option contract is equal to 100 shares, the put option\’s total cost in this instance is $100.00.

In this example, we have the option (but not the obligation) to sell 100 shares of the XYZ stock at the $45 strike price prior to the contract\’s expiration date.