Isn't exercise&close for options in-the-money beyond commissions always better than selling them?

Question

I believe that the wrong answer to this question has been given on Yahoo!Answers & should be removed. The value of options go up only about half of the stock's rise because any buyer would want to get that much of the value out of the deal. If you can afford it, for a PUT you buy the stock at the current low price so that you can exercise your in-the-money PUT to sell the stock at the PUT's higher strike price -- or -- for an in-the-money CALL, you exercise the CALL to buy the stock at the CALL's lower strike price so you can immediately sell it at the currently higher price; you will make more profit that way than from merely selling the in-the-money option. You have to allow for commissions.

Please identify your financial background & experience when answering.

Answer 1

It is usually more profitable to sell an option than it is to exercise it. The reason is that most options have some extrinsic value (time premium) available in the bid quote.

For some deep in the money options the bid quote may be less than the intrinsic value of the option, in which case it could be more profitable to exercise the option.

If I bring up the option chain montage for GOOG at

http://www.cboe.com/DelayedQuote/QuoteTa...

after clicking "List all options, LEAPS, Credit Options & Weeklys if avail." I get the quotes as of today's close Friday, July 11.

The stock, GOOG, closed at $533.80.

Let's assume I owned a $400 call option, a $500 call option, a $550 put option and a $700 put option.

As of the close, the bid on the $500 call option was $40.80 so I could sell the option for $4,080. If I exercised the option I would buy 100 shares of the stock for $50,000 which I could then immediately sell for $53,380. Since $53,380 - $50,000 is only $3,380 I would make $700 less by exercising the option.

Similarly, the bid on the $550 put option was $27.50 so if I sold the option I would receive $2,750. If I exercised the option I would receive $55,000 for 100 shares which cost me $53,380, netting $55,000 - $53,380 = $1,620 or $1,130 less than I would have received by selling the option.

For the two options with strike prices reasonably close to the stock price, it would clearly be better to sell the option than to exercise it.

Now let's look at the two deep in the money options.

The bid price on the $400 call was $132.70, so if I sold the call with a market order you would only get $13,270 but if I exercised the call and sold the stock you would get $53,380 - $40,000 = $13,380 or $110 more.

The bid price on the $700 put option was $163.70, so if I sold the put with a market order you would get $16,370. If I bought the stock and exercised the option you would get $70,000 - $53,380 = $16,620 or $250 more.

It is worth noting that the bid-ask spread is usually quite large in deep in the money options and you usually can use a limit order to get a better price than you would get with a market order, but I would not expect you to get more than you could make by exercising the deep in the money option.

If you still think it would usually be better to exercise the option, try to find an example where it would be better to exercise the option when the strike price is close to the stock price.