Do Not Exercise Options Early – Here is Why

Video Summary

When you buy or sell a call or put option contract, you’re often concerned with what happens when you exercise the contract early. In reality, exercising the contract early is not a smart move, and the holder of the contract, whether you’re the buyer or seller, should avoid it. The break-even price for exercising a call contract is the strike price plus the premium paid, and if the share price is above the strike price but below the break-even price, exercising the contract early will result in a loss. For example, if you buy a call contract on Costco with a strike price of $320 and a premium of $16.76, and the current market value is $328, exercising the contract early would result in a loss, as the contract’s value would only be $878 compared to the original cost basis of $16.75.

The value of the call contract is made up of both intrinsic and extrinsic value. Intrinsic value is the difference between the share price and the strike price, while extrinsic value is derived from time value and implied volatility. The extrinsic value is the potential for the stock’s price to rise over time, and exercising the contract early would evaporate this value. It’s much better to sell to close the position and let the contract expire, as this allows for the potential for the extrinsic value to increase. Ultimately, exercising a call contract early is a losing proposition, and it’s best to avoid it.

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