The answer is that it generally does not make sense — unless the option is: As a smart OptionsAnimal trader, I bought a protective put. Today, RIMM is trading at My DEC 55 long put is trading at 9. My cost basis in the stock is: Today, I have two choices. I can exercise the long put: A loss is disappointing, but I am confident that I will turn this to a profit, by continuing to manage the collar trade. So, in this situation you can see that exercising early does not make sense.
It is exactly equal to the extrinsic value in the option. So, if you exercise an option early, you sacrifice the extrinsic value of the option. If you were on the other side of that trade — the option seller — you would be thrilled if the buyer decided to exercise early.
If you sold the put, you were probably bullish unless it was part of another trade. Now you were looking at potentially buying back that put, for a significant loss. The difference between the two situations. Yes, you guessed it: That is the extrinsic value. The option buyer just gave you a gift. The bottom line is that when there is significant extrinsic value, it rarely makes sense to exercise an option early.
Unless your option is deep in the money or very close to expiration — when the extrinsic value is nearly zero — it does not make sense. And if you are the option seller, assignment is unlikely when there is significant extrinsic value. That does not mean that it cannot happen. Anyone who buys an option has the right to exercise it.
If you are the seller, you can find yourself assigned. Those need to be considered and may help you make the decision as to whether it is better to exercise or sell.
For call sellers, the most likely scenario of assignment is for dividend paying stocks when the short call is deep in the money. The rule of thumb is that if the price of the put, at the same strike as the short call, is less than the dividend to be paid, assignment of a short call is likely.
Should I close the trade? What was your primary exit? No need to panic. When assignment happens, you win! If the short is going in the money, there may be reason for concern. Generally, that means that your trade went against you and you probably need to be considering your secondary exits. Skip to content When does it make sense to exercise an option early? When does it make sense to exercise an option early?
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