Understanding Options
Options are financial instruments that give the holder the right, but not the obligation, to buy or sell an underlying asset at a specific price before a certain date. When an option holder decides to exercise their option, they are choosing to exercise their right to buy or sell the underlying asset.
Exercising a Call Option
When an investor exercises a call option, they are choosing to buy the underlying asset at the strike price. For example, if you have a call option to buy 100 shares of XYZ stock at $50 per share and the current market price is $60, you can exercise your option to buy the shares at $50 each.
Exercising a Put Option
On the other hand, when an investor exercises a put option, they are choosing to sell the underlying asset at the strike price. Using the same example, if you have a put option to sell 100 shares of XYZ stock at $50 per share and the current market price is $40, you can exercise your option to sell the shares at $50 each.
Reasons to Exercise an Option
- Capture profits: If the option is in the money, exercising can lock in gains.
- Speculate on price movements: Investors may exercise options to capitalize on expected price movements.
- Manage risk: Exercising options can help hedge against potential losses.
Case Study: Exercising a Call Option
Suppose you have a call option to buy 100 shares of ABC stock at $50 per share. If the market price of ABC stock rises to $60, exercising the call option allows you to buy the shares at $50 each and immediately sell them at $60, capturing a $10 profit per share.
Statistics on Exercising Options
According to the Options Clearing Corporation, the average daily volume of options contracts traded in 2020 was over 20 million contracts. This demonstrates the popularity and importance of options trading in the financial markets.
