What is "Exercising" an Option?
The ultimate power of an options contract—and why most traders never use it.
Quick Summary
Exercising means using your option's right to buy (call) or sell (put) 100 shares at the strike price. However, most traders never exercise—they simply sell the contract instead. Why? Because selling captures both intrinsic AND extrinsic value, while exercising only captures intrinsic value.
When you buy an option, you're buying a contract. But eventually, that contract has to turn into something real—or disappear entirely.
While the vast majority of options traders simply buy and sell the contracts themselves for profit (like trading collectibles), the ultimate power of the contract lies in its ability to be exercised.
But what does it actually mean to exercise an option, and more importantly—is it something you should ever do?
The Definition: What is Exercising?
Exercising an option is the act of using the rights granted by the contract to buy or sell the underlying shares of stock.
Exercising a Call
You choose to buy 100 shares of the stock at the strike price. You become a shareholder.
Exercising a Put
You choose to sell 100 shares of the stock at the strike price. (You must own or short the shares.)
Once you exercise an option, the contract ceases to exist. You're no longer holding a derivative—you're now holding (or shorting) the actual stock.
The Mechanics: How Exercising Works
To exercise an option, you give instructions to your broker (usually a button click in your trading app). Here's what happens behind the scenes:
Example: Exercising a Call Option
You hold a Tesla (TSLA) Call with a $200 strike. Tesla is trading at $250.
Click "Exercise"
You notify your broker you want to use your right.
Contract Removed
The option disappears from your account.
Cash Debited
$20,000 is taken from your account ($200 × 100 shares).
Shares Credited
You now own 100 shares of Tesla worth $25,000 ($250 × 100).
Cash Required to Exercise
$20,000
Strike Price ($200) × 100 Shares
The Cash Requirement
You must have sufficient funds to exercise. In the example above, without $20,000 available, your broker will likely reject the request or force you to sell the option contract instead. This is why exercise requests can fail.
The Golden Rule: Why You Should Rarely Exercise
The Secret Most Beginners Don't Know
Most experienced traders never exercise their options. Why? Because exercising throws money away.
Remember that an option's premium consists of two components:
Intrinsic Value
$5.00
Extrinsic Value
$2.00
Total Premium
$7.00
If You Exercise
You convert the option into stock at the strike price.
Value captured: Intrinsic only
You receive: $5.00 worth
The $2.00 extrinsic value is lost forever.
If You Sell
You sell the contract to another trader at market price.
Value captured: Intrinsic + Extrinsic
You receive: $7.00 (full premium)
You keep the entire value of the option.
The Smarter Approach
Instead of exercising, "Sell to Close" the contract. You capture both intrinsic and extrinsic value. If you truly want to own the stock, take that cash and buy shares separately. You'll end up with more money and the same stock position.
The Exceptions: When Exercising Makes Sense
While selling is usually better, there are specific scenarios where exercising is the right move:
Capturing a Dividend
Option holders don't receive dividends—only shareholders do.
If a stock pays a large dividend, it may be worth exercising a call the day before the ex-dividend date to collect the payment.
Illiquid Options
Some options have very low volume with terrible bid prices.
If the bid-ask spread is so wide that selling would cost you more than the extrinsic value, exercising and selling the shares may be better.
Long-Term Ownership
You want to own the stock for years, not trade the option.
If your deep ITM option has almost zero extrinsic value left and you want the shares long-term, exercising simplifies the process.
Automatic Exercise at Expiration
You don't always have to manually choose to exercise. The OCC (Options Clearing Corporation) has a rule:
The Auto-Exercise Rule
If an option is In The Money by $0.01 or more at market close on expiration day, it will be automatically exercised for you—whether you want it or not.
The Danger
If you hold a call that expires ITM but don't have the cash to buy 100 shares, your broker may issue a margin call or liquidate other positions to cover the cost. This can result in unexpected losses and forced sales at bad prices.
The Solution
Always close your option positions before market close on expiration day if you don't want to deal with exercise. Don't let ITM options expire in your account unless you're prepared for the capital requirements.
Frequently Asked Questions
Summary
Exercising is the "nuclear option" of options trading. It converts your temporary contract into a permanent stock position.
While the ability to exercise is the fundamental right that gives options their value, it's rarely the most profitable way to exit a trade. By selling the contract instead, you capture both the intrinsic value AND whatever time value remains.
For the vast majority of traders, the goal is simple: buy the option low, sell the option high—never touching the actual stock in the process.
