When should a Call Option be exercised?

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Call options can help in minimizing portfolio losses. A call option can be exercised at any point in time to earn a premium. Call option holders are not obligated to buy the options, but they can hold options they have as long as they want. So, is there any specific rule to check whether and when to exercise a call option? The answer is "yes", and it should not be hard to earn a premium if the exercise goes well.

Check if the call option is in the money

One would simply never buy an option to get a loss in his or her investments. A simple way to minimize the losses and maximize the profits is to check if the call option is in the money. In other words, if the strike price or the price at which the call option is sold is less than the underlying stock price, the option should be exercised.

For example, if the exercise price is INR 100 and the stock price is INR 80, there is no point in selling the stocks as there would be a loss of INR 20 per share in the option.

Check the earning growth and consistent cash flow of the company

Checking the company’s financials, such as earnings growth and consistent cash flow can help you determine whether the stocks of the company will keep rising in the future. If a call option contains a company’s stock as underlying that has strong fundamentals, you could hold on to the stocks to gain substantial profits in the future. So, in such a case the option should not be exercised.

Compare selling vs exercising the options

If selling the shares underlying a call option offers more profit than exercising the options, one should sell the stocks rather than exercising the options.

For example, calls bought at INR 50 per contract when the share price was INR 200 could be worth INR 60 if the share price goes up to INR 250. The profits would be INR 100 a contract if the owner tends to close out the call position, which is a 20 percent return on investment.

But, if you exercise your rights, buy the shares for INR 200 and then sell them for INR 250 each, your profits would be INR 50 a share, which is a 25% return on investments.

Short selling

A short sale means borrowing stocks from the broker at a lower price that can be sold back when the prices go up. If you do so, but the stock rally continues, call options at appropriate strike prices could reduce losses as you can exercise the options to cover the short selling

Published on 04-Oct-2021 11:22:59