To The Moon

Why Exercise In-The-Money Options Early?

Beginner options buyers often firmly believe that for profitable options, they should either close the position or wait until expiration to exercise. Early exercise is seen as wasting time value.

However, in some situations, early exercise may actually be the wiser choice.

The first scenario is when the underlying asset has a massive upward move, making the call deep in-the-money (or a massive downward move making the put deep in-the-money). While this is certainly a welcome development, deep in-the-money options often suffer from poor liquidity. At this point, if you decide to lock in profits, you may find that the bid-ask spread due to low liquidity can eat into a significant portion of your gains.

By exercising early, since stocks generally have much better liquidity than options, selling the newly acquired shares often leads to higher profits. Other scenarios involving lack of liquidity may also increase the necessity for early exercise, such as when there is a brief, substantial price move well before expiration. If you don't exercise early, the price could quickly revert, rendering the option worthless.

The second scenario is when the underlying stock pays dividends. When a stock goes ex-dividend, its price drops, and call option prices follow suit. However, the dividend payment goes to shareholders, not option holders. Early exercise allows option holders to acquire the shares and capture the dividend payment as well.

So while not used frequently, this early exercise feature can be quite valuable in certain situations.

The issue is that while American-style options allow early exercise, your broker may not support this functionality. Tiger Trade's 9.1.7 version has now enabled the early exercise feature.

Also launched is the option to abandon/not exercise in-the-money options at expiration.

Who would abandon in-the-money options?

For short-term traders who buy options to profit from market movements rather than hold shares, slightly in-the-money option profits may be small, yet tie up substantial account capital. Worse, the position could lose on the next trading day due to price fluctuations. Abandoning the option frees up capital for more flexibility. For traders lacking funds to exercise, it avoids being forced to close the position due to insufficient margin, incurring extra trading costs.

From these examples, we see that by solely focusing on seemingly "correct" simple rules, we may find ourselves unprepared and suffering losses when exceptions arise.

Please update to Tiger Trade 9.1.7 to be better prepared for your options trading needs.

FAQs

1.What are the requirements for early exercise?

Must be a long American-style in-the-money option (long call or long put), with sufficient margin in the account for exercise. Application must be made before market close on the trading day prior to expiration.

2.What are the requirements for abandoning exercise?

Must hold long option positions in the combined account. Application must be made before market close on expiration day.

3.Can I apply for early exercise or abandon for just one leg of a complex option position?

Yes, but if it causes the overall risk to exceed the account's risk limit, the application may be rejected.

4.Can I cancel after applying?

For early exercise, cancellation must be made on the application day before market close. No cancellation allowed after that.

For abandoning exercise, cancellation can be made anytime before expiration day close.