Early Exercise

Recall that only American options can be early exercised, and at any time up to expiration. Most of the time, options are not early exercised, because the time value of the option premium is lost. It is also likely cheaper to trade out of the position, than to exercise the option.

The situation of calls and puts are dealt with seperately.

[This section is still in progress.]

Early exercise for calls

When you exercise a call, you have to pay $X to buy the stock. You will thus lose the interest on the obey.

Because the option represents the ability to own the stock in the future, the owner of a call option is not entitled to dividend payments that occur before the expiration date. Thus, he might want to exercise the call option just before the ex-dividend date, in order to capture the dividend paid. Note that call options on stocks which do not pay dividends, are (almost) never early exercised.

The necessary conditions for early exercise of calls is:
1. The delta of the call is 1.
2. The option value of the call is equal to the intrinsic value.
3. The dividend is more valuable than the protection of the put.

Early exercise for puts

When you exercise a put, you get to sell the stock for $X. This allows you to earn interest on the money.

The necessary conditions for early exercise of puts is:
1. The delta of the put is -1.
2. The option value of the put is equal to the intrinsic value.

As an option seller, you are at risk of being assigned an early exercise at any time. Ignoring for drastic overnight price movements, it is usually beneficial to be assigned, as you then gain the insurance that the other party has given up.

Early exercise in a multi-leg strategy