When it makes sense to Early-Exercise a position

[Slow Learning Elf]

It never makes sense to exercise an option early if there is any extrinsic value left in the option. If you want a stock position, you would be better off selling the option and then trading the stock (which you can do as a spread). You will end up with the same position as exercising, but will have captured the options extrinsic value, which you lose by exercising.

Just for completeness sake, there are special situations when early exercise makes sense even through option theory tells you otherwise. Usually, these are either related to tradeabily of the underlying vs the option or due to some special features that would not result in adjustment of the options contract but will significantly change the price of the underlying.

 

[taowave]

When you say short selling,are you referring to a synthetic put position,and the stock becomes impossible to borrow??

I said closing b/c the latter example was about ShortSelling.

 

[FSU]

Just for completeness sake, there are special situations when early exercise makes sense even through option theory tells you otherwise. Usually, these are either related to tradeabily of the underlying vs the option or due to some special features that would not result in adjustment of the options contract but will significantly change the price of the underlying.

I listed in another post when it may make sense to exercise early. What you quoted and responded to was my statement that you should never exercise early if an option has extrinsic value that you could sell it for.

 

[Quanto]

So, yes, in that case an early-exercise is sub-optimal over an early-close.
But this still does not answer the question whether it's better to keeping it till the expiration date.
IMO in this case an early-close or early-exercise is better than keeping it till expiry.
The annualized result will show it.

As suspected, here the proof of the above said:

CALL
S0=5.0000 DTE=60 Pr=0.5000(IV=61.99) rPct=0.00 qPct=0.00
Sx=6.0000 DTE=50 Pr=1.1000(IV=52.64) rPct=0.00 qPct=0.00

Calculations (w/o commissions):
Early-Close:                 PL=0.6000   (120.00% in 10 days --> 1000.36% p.m.)
Early-Exercise:              PL=0.5000   (100.00% in 10 days --> 723.44% p.m.)
Auto-Exercise-at-Expiration: PL=0.5000   (100.00% in 60 days --> 42.10% p.m.)

p.m. : per month

Early-Closing gives the highest profit, Early-Exercise is 2nd, and Auto-Exercise-at-Expiration gives the least profit. Q.E.D.

I even claim that there are much more situations/possibilities/opportunities where an early-close or early-exercise makes more profit than auto-exercise-at-epiration, simply due to the formula "time is money"...
These findings (facts) prove "the theory" and many experts wrong...

 

[Quanto]

When you say short selling,are you referring to a synthetic put position,and the stock becomes impossible to borrow??

No, I just mean basic ShortSelling, and closing it before expiration (b/c it cannot generate any more profit b/c with ShortSelling the max possible profit is known in advance... Just simple maths).

 

[Slow Learning Elf]

I listed in another post when it may make sense to exercise early. What you quoted and responded to was my statement that you should never exercise early if an option has extrinsic value that you could sell it for.

Yeah, I saw it later! All good

 

[Quanto]

As suspected, here the proof of the above said:

CALL
S0=5.0000 DTE=60 Pr=0.5000(IV=61.99) rPct=0.00 qPct=0.00
Sx=6.0000 DTE=50 Pr=1.1000(IV=52.64) rPct=0.00 qPct=0.00

Calculations (w/o commissions):
Early-Close:                 PL=0.6000   (120.00% in 10 days --> 1000.36% p.m.)
Early-Exercise:              PL=0.5000   (100.00% in 10 days --> 723.44% p.m.)
Auto-Exercise-at-Expiration: PL=0.5000   (100.00% in 60 days --> 42.10% p.m.)

p.m. : per month

Early-Closing gives the highest profit, Early-Exercise is 2nd, and Auto-Exercise-at-Expiration gives the least profit. Q.E.D.

I even claim that there are much more situations/possibilities/opportunities where an early-close or early-exercise makes more profit than auto-exercise-at-epiration, simply due to the formula "time is money"...
These findings (facts) prove "the theory" and many experts wrong...

A slightly extended output:

CALL K=5.00
S0=5.0000 DTE=60 Pr=0.5000(IV=61.99) rPct=0.00 qPct=0.00
Sx=6.0000 DTE=50 Pr=1.1000(IV=52.64) rPct=0.00 qPct=0.00

Calculations (w/o commissions):
Early-Close:                 Pr=1.1000   PL=0.6000  (120.00% in 10 days --> 1000.36% p.m.)
Early-Exercise:              Pr=1.1000   PL=0.5000  (100.00% in 10 days --> 723.44% p.m.)
Auto-Exercise-at-Expiration: Pr=1.0000   PL=0.5000  (100.00% in 60 days --> 42.10% p.m.)

p.m. : per month = 1/12 years = 365.00/12 days = 30.416667 days

Sometime later I'll do also a brute-force search to find the optimum as I suspect there must be an optimum point in time.

 

[taowave]

You realize that by exercising, by and large you are giving away a free option with no compensation..

 

[Quanto]

You realize that by exercising, by and large you are giving away a free option with no compensation..

You should be more specific, and explain what you mean. Why do you think it's w/o compensation?

 

[taowave]

I dont think,I know

Do you understand synthetics.i.e put and call???