Early Exercise
Categories: Investing, Derivatives, Company Management
Those people out jogging at 5 am. You know they just do it to show you up...
In options trading, an early exercise occurs when an options contract is cashed in before its expiration date. When you buy an options contract (a deal that gives you the right to buy or sell something...like a stock or a commodity...at a certain price), it comes with an expiration date. Some options can only get activated on the exercise date. Others allow you to do it any time prior to the exercise date. When you close out early, that's an early exercise.
Example: it's February 1 and you buy an option that gives you the right to purchase 100 shares of Love Potion Chemical Co. at $50 per share. The option has an exercise date of March 1. As February starts, the stock is trading at $45 per share.
But for reasons you can't figure out, the stock spikes on February 14 and is now trading at $55 per share. Rather than hope the price increase stays until the end of the month, you elect to exercise your option early. You cash in the option, buying shares at the pre-arranged price of $50 per share. You then immediately sell them for the current value of $55 per share, and bank the extra $5. For the 100 share, you earn a total profit of $500 (minus whatever it cost you to buy the option).
Then you go home with nothing more than a happy story about earning $500 in the options market, only to find your spouse expectantly waiting, first with an air of flirty anticipation, then with an attitude that slowly morphs from confusion to annoyance and then to downright hostility...for reasons you can't figure out.
Related or Semi-related Video
Finance: What is a Strike Price?40 Views
Finance a la shmoop what is a strike price well before going
even a second further with this video be sure you've seen our Steven Spielberg [Introduction to a movie at the cinema directed by Steven Spielberg]
directed what is a stock option video here are the reviews from variety.. well
to review a stock option is the right to buy a share of stock for a set price
over a given period of time so let's say you were granted an option to buy a [Graph of amazon stock prices]
share of Amazon stock in 2015 when the stock was around 400 bucks a share the
option lasts as long as you work at the company in good standing or after 10
years have passed which ever ends first well one day you decide you want another job [Woman signing a contract]
your contract says that if you're no longer an employee with the company then
you have 90 days in which to either buy out your option that is to buy the
option and then own the stock or just forfeit the option [Woman underlining words on a contract]
well since Amazon is now at a thousand bucks a share you obviously don't want
to forfeit the option to buy that share of stock for 400 bucks but you note that
your many friends who joined apcray.com at a high price a high strike price which
creators know they're stock while they're doing a lot of option forfeiting
that is their options ended up being worthless so you've got a lot to think [Man holding out a bag of dog poo]
about here this is Amazon not apcray so you want to buy out your option so
what happens well you were granted your own options at the price Amazon stock [Amazon box falls off shelf]
was trading at the day you joined the company it was 400 bucks a share so
that's a strike price that $400 is the price you pay to buy a share of stock at
some point there in the future that strike price has nothing to do with [Protestors holding signs outside an Amazon building]
unions not working got it? all right well in order to buy that stock it's
currently trading in a thousand bucks a share
you pay Amazon 400 bucks and that buys out your option you then own the stock [Man writing a check to Amazon for 400 dollars]
that's it Amazon cancel your option then they give
you a share of actual stock which you now own for as long as you want to own [Man delivering an Amazon box]
it you can sell it immediately and make a
$600 a share profit that's a thousand bucks a share it's trading at now minus the
$400 strike price you just paid to buy out that option got it or you can hold [Grandparent bribing grand-daughter for amazon stock]
onto those shares and you know use it to bribe your grandchildren one day it's
worth like a million dollars a share