Options 101: Three Ways to Trade
Deciding whether to sell it, exercise it, or allow it to expire.
If you own an option, you have 3 choices. And that's true whether you own a call or a put.
1. You can sell it.
- If you collect more than you paid, you earned a profit.
- If you collect less than you paid, you have a loss.
- You bought this option by entering a buy order with your broker. This time you enter a sell order. Some brokers require that you specify the order is "sell to close." That means you own the option and are selling it to reduce, or eliminate a position.
2. You can exercise it by notifying your broker.
Although you won't make this choice often, exercising means you want to do what the contract allows. Thus:
- If you own a call option, you buy 100 shares of the underlying stock by paying the strike price per share.
If you own a put option, you sell 100 shares of the underlying stock and collect the strike price per share.
The trade occurs overnight. When you see your account the morning after you tell your broker to exercise, you'll see that the transaction occurred when the stock market was closed.
3. You can allow it to expire worthless.
- This isn't usually the ideal solution, because it means you lost every penny you paid to buy the option. However, if you used this option to hedge another position, you may have earned a profit that exceeds this loss.
When you hold an option, hoping for a favorable movement in the underlying stock price, many times that move never occurs and your option is out-of-the-money.
When an option is out-of-the-money when expiration arrives, it has no value and is officially worthless. Because it expires, your right to buy the underlying stock expires.
You may try to sell an option before it expires, but if there's little time before expiration, or if the option is out-of-the-money by a significant amount, you may discover that no one is willing to buy the option. If that happens, you still own the option and it will expire and become worthless.
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