I understand the logic for call options. When dividends exceed the time value left, then it is profitable to early exercise a call.

But the same does not hold for a put. So, when to early exercise a put?

  • When dividends exceed the time value left, then it is profitable to early exercise a call. Can you provide a numerical example that supports this conclusion? Namely, the stock and strike price as well as the bid/ask of the call? Mar 5 '21 at 13:02

When you want the transaction to be concluded in the current year vs an expiration in the next year.

  • If the profit from selling the put were short term but the stock held long term, it might be advantageous to exercise early. Apr 22 '15 at 21:31
  • Thanks. So it is only tax considerations that determine the early exercise?
    – Victor123
    Apr 23 '15 at 13:19
  • That was all I could think of. Apr 23 '15 at 13:36
  • It makes no sense to exercise an ITM put if it has time premium remaining because doing so throws away that time premium. The exception would be if the time premium was less that the aggregate commission cost to exercise to close (this question was asked in 2015 before brokers went to no commission trading). The possibility not mentioned is that if the time premium of the ITM put is less than the amount of a pending dividend then there's an arbitrage available that locks in the difference. Mar 5 '21 at 13:08

There are multiple issues in your question as well as in the answers/comments that you received.

If a deep in the money option has time premium remaining, it makes no sense to exercise it since you would be throwing away the time premium by doing so. The exception to this would be if your closing commission costs exceed that time premium.

With deep ITM options, the bid is often below intrinsic value. Sometimes it can be as much as 25-35 cents, or more. You could try for some price improvement with your STC order but there is no incentive for the market maker or anyone else to give you the full intrinsic value. While waiting for a better fill, the price of XYZ could change and you could give back some of your intrinsic value.

To avoid this haircut, you could perform the same Discount Arbitrage that a market maker would do. Assume that it's a deep ITM call. Short the stock and then exercise the call. That locks in the intrinsic value and avoids the haircut (short the stock first to avoid slippage). Example:

XYZ is $40 Sep $35 call is $4.80

The intrinsic value of the call is 5 points. Short the stock at $40 and exercise the call to buy the stock at $35 (+ $40 - $ 35) = $5 (20 cents better than selling the call to close).

The trade off is that by holding the call to get the dividend(s), you risk losing a lot of intrinsic value if the stock collapses so your decision should be based on your outlook for the underlying, not the possibility of receiving a dividend.

It is a misconception that when dividends exceed the time value left, then it is profitable to early exercise a call. The dividend arbitrage exists for the ITM put, not the ITM call. Example:

XYZ is $40 Sep $45 put is $5.30 ex div is tomorrow and it is 50 cts

Buy stock, buy put, exercise after ex-div

  • $40.00 - $5.30 + $45.00 + $.50 = + 20 cents

Why doesn't this exist for the ITM call? Share price is reduced by the stock exchanges by the amount of the dividend so there is no profit there. If you exercise a call with time premium remaining, you throw away the time premium and the so called arb is done at a loss.

  • 1
    This was insanely helpful. Thank you for taking the time to write it. Mar 5 '21 at 5:44

When you exercise a put, you get paid the strike price immediately. So you can invest that money and earn some interest, compared to only exercising at expiry.

So the benefit to exercising early is that extra interest. The cost is the remaining time value of the option, along with any dividend payments you miss.

As @JoeTaxpayer points out, there might be tax considerations that make it better to exercise at one time rather than another. But those would likely be personal to you, so if the option would intrinsically have more value unexercised, in many cases you could sell it on rather than exercise it. The exception might be if it wasn't very liquid and the transaction costs of doing that outweighed the theoretical value.

  • Can you elaborate a bit?I could not understand.
    – Victor123
    Apr 23 '15 at 13:20
  • How's that edit? Apr 23 '15 at 18:47
  • Ok got it thanks. You dont just miss dividend payments when you exercise a put. Because of the short stock position, you actually owe dividends. man that would need to be a fairly high interest rate to justify loss of time value, owed dividends + short stock interest and fees. But I got your point, thanks for the edit.
    – Victor123
    Apr 23 '15 at 19:10
  • You can just buy in the market to exercise the put rather than going short and paying fees for that (and taking a risk of price movements). But the price you have to pay for the stock will take dividend payments into account - it'll be higher before a dividend payment and lower after. Apr 23 '15 at 19:35
  • Also, bear in mind that if the option is deep in the money the time value would be very low. Apr 23 '15 at 21:04

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.