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Note: I am not a financial planner and do not claim to be one. While I understand the writing below to be accurate, please contact a financial planner before making major investment decisions.
Stock options are an important part of the trading world especially for day traders. If you ever have bought a call option and held it to expiration you will have a choice on whether to sell the option or exercise it.
When it comes to stock options, is it better to sell or exercise them?
For most people it is better to sell the call/put option rather than exercise it as you will avoid additional transaction fees that way. By exercising an option you are able to buy (with a call) or sell (with a put) a certain stock but most people just use options to try and make profits not to buy or sell actual shares
If a stock’s strike price is lower than its market value you will want to do something with it as the option has intrinsic value. If you let the option expire without selling or exercising it you will lose that intrinsic value.
Buying and selling stock options is an important, but sometimes risky financial decision. Read on to learn more about when it is best to sell an option and when it is best to exercise a stock option.
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When To Sell a Stock Option
Selling a stock option means that you are selling the ability to someone to buy or sell a stock at a specific, predetermined price, regardless of the current market value. If the decision is made to sell the option, then you are forfeiting your right to buy or sell a stock to someone else but you are getting paid to do so (the option premium).
While this can be a financially sound decision, whether or not to sell a stock option depends on several factors, including the stock’s strike price, the stock’s market value, and whether or not the option is a call or put option.
If, for example, you have a call option, this means you have the right, but not the obligation, to purchase a stock at a predetermined value within a specific amount of time. For example, let’s say that the predetermined purchase price (AKA the strike price) may be $20 on a stock.
If you do not believe that the stock will reach the price of $20 by the expiration date, but others might believe it because the stock’s price is on the rise, then you would want to sell the call option.
Should you decide that you would like to sell the call option mentioned in the example above, then you are betting that the stock will not rise above $20 in that time prior to expiration.
If the stock does not reach $20 and it, instead, reaches only $19, then you were better offer selling your option than holding it until expiration.
In a put option, this is the exact opposite. A put option means you have the right, but not the obligation, to sell a stock at a predetermined value within a specific amount of time. This means that, in the same example, you might have the ability to sell the stock for $20 regardless of market value.
If you believe the price of a stock will not fall below the price of $20, but others might believe it will, then you may decide you want to sell your put option.
Using the example above, if you decide to sell the put option, you are betting that a stock will not fall below the price of $20 within the specified window. If the stock does fall below $20 to $19, you would have been better off holding the put option rather than selling it.
However, if the stock does not fall below $20, and it, instead, stays at $21, then your decision was a good one.
Exactly when you sell your stock option depends on your trading plan and how much profit you already have. If you have a 20% profit in the option premium since you bought it and that was the target profit for the trade then you might want to sell it even if you believe the stock will move further.
With options it is vitally important to have a trading plan and stick to that plan to help you secure profits and take losses.
When To Exercise a Stock Option
The decision to exercise a stock option is often much easier than the decision to sell a stock option. Exercising an option simply means that you are utilizing your right to buy or sell a stock at the strike price, depending on if you hold a call or put option.
If you choose to exercise your call option, you are simply using your ability to purchase the stock at the strike price. If you choose to exercise your put option, you are using your ability to sell your stock at the strike price.
When deciding to exercise a call option, you would do so if you believe the price of a stock will rise, or if the market value of a stock is already above the strike price.
For example, if the current value of a stock is $50, and the strike price your stock option provides is $40, then you may decide you want to exercise the stock option, as you would be buying a stock at a discounted rate.
Alternatively, if you have a put option, you may decide to exercise the option if the strike price is above the market value, or if you think the value of the stock will decrease below the strike price.
For example, if the current market value of a stock is $40, but the strike price listed in your put option is $50, it may make sense financially to exercise the put option because you can sell your stock at a price higher than the market value.
When it comes to exercising stock options, there are some different techniques. It is important to consult with your financial advisor if it is best to sell or exercise stock options and which technique is the best.
Here is a short description of the techniques:
- Exercise and Hold: This is when you exercise your option to purchase a stock, and, instead of selling it, choose to hold onto the stock.
- Exercise and Sell: This is when you exercise your option to purchase stock, and, rather than holding onto the stock, you decide to sell it immediately for a profit.
- Exercise and Sell to Cover: This is when you exercise your option to purchase stock and decide to sell enough stock so that you can make enough to cover the purchase, fees, and taxes on stocks, but hold the rest.
Deciding between selling your put/call and exercising it can be difficult but in most situations and for most investors it is better to sell the option than it is to exercise it.
By selling the option you will get the same profit as you would when exercising it but you avoid the extra transaction fees of exercising.
So unless you want to buy that stock for a king term hold (in the case of a call) or want to sell some stock that you already own at the strike price (in the case of a put) you are better off just selling the call or put option.