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As a follow up to my other question, I would like to know whether the following is possible:

  1. I have $20,000 in my brokerage account
  2. The price of a call option with $300 strike price is $5.00 (1 contract = 100 shares)
  3. I buy 20 contracts of these $300 calls (cost is 20 * 5 * 100 = $10,000)
  4. The price of the underlying goes up, making my option in-the-money

I decide to exercise my options.

Exercising my calls means that I buy 20 * 100 = 2,000 shares of the underlying at $300 per share. However, I only have $10,000 left in my brokerage account and am unable to pay for the shares (2,000 * 300 = $600,000).

What now? How does this work? Do brokers recognize that my position is profitable, and buy and sell the underlying for me as soon as I exercise my calls?

In other words, do I need to worry about being able to pay for the shares of the underlying if I decide to exercise my options? Can I just take my profit without bothering with the shares at all?

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    Have you ever read something called "Option Value = Intrinsic Value + Time Value"? By excercising the option earlier than maturity, you immediately lose the Time Value portion of the current option price.
    – base64
    Jun 12, 2015 at 11:31
  • @base64: I have, and this post clarifies that it makes sense for deep-in-the-money options. Also, if I think the price of the asset will be lower at maturity then it is now, wouldn't it make sense to exercise?
    – Jean-Paul
    Jun 12, 2015 at 12:02
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    Why do you think that the payoff you receive now by exercising is higher than the payoff you receive now by selling them to close the positions? I mean, its just two numbers. A > B then always prefer A.
    – base64
    Jun 12, 2015 at 12:06
  • @base64: I don't. I am trying to learn this stuff that's why I'm asking. What you suggest now is the exact topic of my other question (which I linked to in this question). So are you suggesting that I can simply trade options as leveraged products without bothering about the underlying shares? (mind you: I only have theoretical knowledge about options, no experience)
    – Jean-Paul
    Jun 12, 2015 at 12:09
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    @base64: I have just edited my question to leave out the early-exercise part. I am still wondering what happens with in-the-money options at maturity if the person can't actually buy the shares (and margin being very high like the $600,000 from my example)
    – Jean-Paul
    Jun 12, 2015 at 12:22

8 Answers 8

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This is dependent on the broker according to The Options Industry Council.

Your broker will specify what they would do upon expiry (or hours before last trade) if you did not indicate your preference. Most likely they will conduct a probabilistic simulation to see whether exercising the contracts may result in margin deficit even after selling the delivered shares under extreme circumstances. In most cases, brokers tend to liquidate the option for you (sell to close) before expiry.

I've seen people complain about certain brokers forcing liquidation at terrible bid-ask spreads even though the options are still days to expiry. It is better for you to close the position on your own beforehand. The best brokers would allow margin deficit and let you deposit the required amount of money afterward.

Please consult your broker's materials. If you can't find them, use live chat or email tickets.

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  • Perfect. Thank you. Just one detail: when selling to close, is there also a buying party? Surely someone must end up with the expired contracts?
    – Jean-Paul
    Jun 12, 2015 at 13:01
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    Yes but the counterparty could just be buying to close their short call position. They could also exercise the option after buying it from you. They have plenty of money.
    – base64
    Jun 12, 2015 at 13:08
  • Understood. Now it's crystal clear to me, thanks :)
    – Jean-Paul
    Jun 12, 2015 at 13:09
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You may want to Sell part of the number of contracts ( say 18 out of 20) and use that proceed along with 10K that you have. So later 2 options will be exercised.

Also you said 200 * 300 = $600,000 and it should be 2000 * 300 = $600,000

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3

It would be nice if the broker could be instructed to clear out the position for you, but in my experience the broker will simply give you the shares that you can't afford, then freeze your account because you are over your margin limit, and issue a margin call.

This happened to me recently because of a dumb mistake: options I paid $200 for and expected to expire worthless, ended up slightly ITM, so they were auto-exercised on Friday for about $20k, and my account was frozen (only able to close positions). By the next Monday, market news had shifted the stock against me and I had to sell it at a loss of $1200 to meet the margin call. This kind of thing is what gives option trading a reputation for danger: A supposedly max-$200-risk turned into a 6x greater loss. I see no reason to ever exercise, I always try to close my positions, but these things can happen.

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    In that scenario, isn't it possible to not exercise the contracts? Surely you have the privilege to decide on that, being you bought the contracts.
    – Jean-Paul
    Jul 8, 2015 at 10:08
  • Yes, you can tell your broker not to exercise, that was the mistake - assuming they would expire OTM.
    – Dirigible
    Jul 8, 2015 at 21:18
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    How do you tell your broker this? Is there an option for this in the software you use?
    – Jean-Paul
    Jul 8, 2015 at 21:21
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    AFAIK you have to contact them directly. I know, so low tech.
    – Dirigible
    Jul 10, 2015 at 1:46
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Unless you want to own the actual shares, you should simply sell the call option.By doing so you actual collect the profits (including any remaining time-value) of your position without ever needing to own the actual shares.

Please be aware that you do not need to wait until maturity of the call option to sell it. Also the longer you wait, more and more of the time value embedded in the option's price will disappear which means your "profit" will go down.

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2

As other answers state, selling the options contracts to the market is a definite way out, and probably the best in most cases. If you're determined to exercise your options (or there's not enough liquidity to reasonably sell your contracts to the market), then you could plan ahead and exercise smaller number of contracts at a time and sell the resulting position in the underlying, which will give you funds to exercise some more contracts and sell the underlying. If you think you're going down this path, however, make sure that you take into account your broker's rules for settlement. You may need to start the exercise / sell cycle before the option's expiration date.

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I know this is like 6 years old, but I just ran into this issue too. The short answer is it depends on the brokerage.

I have TD Ameritrade. I had 8 options (800 shares) @ $40 strike price. It was in the money and I stood to make a pretty solid profit. But if I were to try and exercise the option, TD would want me to have all $32K (800 * $40) in my account, even though the shares would be immediately liquidated for profit.

This can be circumvented if you apply for margin trading. But you have to qualify for that separately, and margin trading can introduce new levels of risk.

For some other brokerages - Robinhood, for example - you can be approved for options and margin trading right away.

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Yes, this can be all resolved by placing a call to the broker and submitting a "Do Not Exercise" order. If it expires ITM and you don't want the shares then you just forfeit the premium paid for the contracts.

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  • A Do Not Exercise order would only forfeit the current value of the option. If this was at expiry then the forfeit amount would be the intrinsic value of the ITM call.
    – Bob Baerker
    Oct 26, 2018 at 17:17
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Yes it is possible to do what you are asking. See following two transaction types at Fidelity:

https://www.fidelity.com/products/stockoptions/exercise.shtml

Initiate an Exercise-and-Sell-to-Cover Transaction

Exercise your stock options to buy shares of your company stock, then sell just enough of the company shares (at the same time) to cover the stock option cost, taxes, and brokerage commissions and fees. The proceeds you receive from an exercise-and-sell-to-cover transaction will be shares of stock. You may receive a residual amount in cash.

The advantages of this approach are:

benefits of stock ownership in your company, (including any dividends) potential appreciation of the price of your company's common stock. the ability to cover the stock option cost, taxes and brokerage commissions and any fees with proceeds from the sale.

Initiate an Exercise-and-Sell Transaction (cashless)

With this transaction, which is only available from Fidelity if your stock option plan is managed by Fidelity, you may exercise your stock option to buy your company stock and sell the acquired shares at the same time without using your own cash.

The proceeds you receive from an exercise-and-sell transaction are equal to the fair market value of the stock minus the grant price and required tax withholding and brokerage commission and any fees (your gain).

The advantages of this approach are:

cash (the proceeds from your exercise) the opportunity to use the proceeds to diversify the investments in your portfolio through your companion Fidelity Account

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  • The question is about exchange traded options not employee stock options.
    – Bob Baerker
    Jan 2, 2020 at 18:37
  • oh should i delete it then if its not applicable?
    – morpheus
    Jan 2, 2020 at 20:24
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    I'd leave it be since you went to the effort of answering it and since it's informative.
    – Bob Baerker
    Jan 2, 2020 at 20:29
  • I suppose your broker might offer these two transaction types anyway, in addition to the obvious sale of the option itself.
    – gnasher729
    Jan 2, 2020 at 23:28

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