When to exercise call options early

We often use strategies that involve call options around dividend ex-date. Often times we sell calls and they might get exercised (for example our dividend capture strategies) and other times we use call options as stock replacements and we are faced with the question if to exercise call options early.

 When should I exercise call options early?

Buying a call option is like using ‘payments’ to buy a stock position. Assuming the time premium is acceptable, you need less cash to enter a position and thus it is better to hold a call option as replacement for a stock position. This is not the case when dividend is distributed and option holders are not entitled to it.

Before Ex-date you should exercise the call option in 3 common scenarios:

  1. The option has almost no time value.
  2. The option is deep in the money and delta is almost 100
  3. The dividend is relatively high and close to expiration

All scenarios are very similar. The rational revolves around the time premium before the dividend and after. Understanding this rational will help you decide on exercising and predict if your sold call will be assigned.

Position Example:

I wish to give examples that are less ‘clear cut’ and more similar to trading, in order to better represent real situations in the market.

The first example is similar to BX position with recent dividend distribution:

Early Option Exercise - Example 1
Early Option Exercise – Example 1

In this case we are checking call option at strike 41.5 when the stock is at 41.76 (i.e just at the money). The premium is 0.3 so the time premium is 4$ (0.04).

We can see that if we don’t exercise, we lose – even if the option premium rises to 7$. This is due to the fact that the option premium is negligible.  Even if we exercise, we see that we lose the time premium, but we still lose less.

So in that case – If we have the cash, it is preferable to exercise.

Let’s examine another example, this time with a larger time premium:

Early Option Exercise - Example 2
Early Option Exercise – Example 2

This time the cost of the option is 100$, so the premium is 74$. We can see that if we assume that the option will have value (logical assumption, especially if the option has long time to maturity) we can see that we shouldn’t exercise.

summary

  • If you are short call that is ITM before ex-date you are likely to be assigned, then you should try to roll the option further and maybe closer ATM. This way you take the time premium sooner and can enter the position again after ex-date.
  • If you are long call, you might want to take the stock before dividend and start selling covered calls. Alternatively, you can sell the call and get back after ex-date.

 

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