Episode Details

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People are often confused as to when it makes sense to exercise an option. Most of the time it does not make sense to early exercise American options. In this video we go through the scenarios where it might make sense.

For an American-style call option, early exercise is a possibility whenever the benefits of being long the underlying outweighs the cost of giving up the option early (the benefits of being long the underlying outweigh the foregone time value of the option). For example, on the day before an ex-dividend date, it may make sense to exercise an equity call option early in order to collect the dividend. In general, equity call options should only be exercised early on the day before an ex-dividend date, and then only for deep in-the-money options when the dividend is sufficiently large

For an American-style put option, early exercise might make sense if it is deep in-the-money. In this case, it may be wise to exercise the option early in order to obtain the intrinsic value (K – S) earlier so that it can start to earn interest immediately. This is somewhat more likely to be worthwhile if there is no ex-dividend date, which would probably cause the price of the underlying to fall further between now and the expiry date. This would usually require interest rates to be relatively high.




When should I exercise an option?

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