Can You Exercise Options Before Expiration?

An option is a financial contract granting its holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined strike price within a specified timeframe. Exercising an option means putting this contractual right into action, converting the option into ownership of the underlying asset or a cash settlement.

Exercising Options Before Expiration

Options can generally be exercised before their expiration date, a feature of “American-style” options. Most publicly traded equity options and many employee stock options are American-style, allowing exercise at any point from the grant date until expiration. This contrasts with “European-style” options, which can only be exercised on their expiration date.

Exercising a call option means purchasing the underlying asset, typically shares of stock, at the strike price. Exercising a put option involves selling the underlying asset at the strike price. For instance, if you hold a call option for 100 shares at a $50 strike price and the stock trades at $60, exercising allows you to buy those shares for $50 each, realizing a $10 per share gain before considering the option premium.

Factors for Early Exercise Decisions

Several factors influence the decision to exercise an option before its scheduled expiration. Intrinsic value is a primary consideration; an option is “in-the-money” when the underlying asset’s price is favorable compared to the strike price, giving it intrinsic value.

Time value decay is another factor, as options lose value approaching expiration. Early exercise may be considered if the remaining time value is minimal. For call options on dividend-paying stocks, exercising before the ex-dividend date allows the holder to become a shareholder and receive the upcoming dividend payment.

Tax implications are a significant driver for early exercise, particularly with employee stock options like Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs). When NSOs are exercised, the difference between the fair market value of the shares at exercise and the strike price is taxed as ordinary income, subject to federal income tax, Social Security, and Medicare taxes.

For ISOs, exercising does not trigger ordinary income tax at the time of exercise. However, the “bargain element”—the difference between the market price and the strike price—is considered income for Alternative Minimum Tax (AMT) purposes. Company events, such as a merger, acquisition, or initial public offering (IPO), can also prompt early exercise to secure gains or participate in the event. An individual’s personal financial situation, including liquidity needs, portfolio diversification, or managing risk exposure, can also lead to an early exercise decision.

Executing an Option Exercise

Executing an option exercise involves practical steps for both publicly traded and employee stock options. For publicly traded options, the process begins by logging into your brokerage account. Navigate to the options section, select the specific option contract, and choose the “exercise” function.

After confirming the transaction, shares of the underlying asset are deposited into your account, and cash equivalent to the strike price multiplied by the number of shares is withdrawn. For employee stock options, the exercise process occurs through the company’s designated online portal. You select the options to exercise and choose an exercise method.

Common exercise methods include paying cash to purchase the shares, or a “cashless exercise.” A cashless exercise involves selling a portion of newly acquired shares to cover the exercise cost, taxes, and any associated fees. Another cashless method involves selling all acquired shares to provide immediate liquidity after covering costs. After the exercise, the shares become part of your investment portfolio, or the cash proceeds are settled.