What is difference between 'square off' and 'exercise' in case of option trading........?

Question

What is difference between 'square off' and 'exercise' in case of option trading........?

Answer 1

some query on this dilemma - difference between exercise and square off?

I searched thru net and this forum and I did find some queries and answers to them, though the questioners were satisfied, I am still not sure or satisfied with the answers so here I go.

1. What is more profitable(theoretically, practically, by experience, etc) squareoff or exercise?

2. when to go for which?

3. which one gives more profit and in what situation?

4. how is the calculation done? For this I will take an example. Support if I had PowerGrid Call Option with Strike Price 105 @9.5 premium. On the day of expiry, this contract was @33-40 premium and Spot price was 136-140. which one would have been profitable and how would the calculation be?

Square Off

(Premium@sell - Premium@buy)*lot size

Exercise

(SpotPrice@close - Strike Price)*lot size?

(SpotPrice@sell - Strike Price)*lot size?

(SpotPrice@(depending of your answer) - (Strike Price+ Premium))*lot size?

more permutation......?

For simplicity sake please assume ONLY CALL Option and use the above example.

5. Which of them -square off or exercise is more riskier(market falling as expiry nears due to volatility, time decay, etc)

6. how will the settlement be done in both the cases. I know in case of square of the settlement is diff. bet. premium amounts. in case of exercise diff. bet. (Strike & Spot price)*lot size?

Plus in case of exercise it is a lot riskier since the Spot price is EOD price and not CMP right?

I know these are lot of questions but trust me they must have occurred to all people at some point in the process of trading and this forum is full of them time and again so let this be a definitive thread to close them all. then this thread can be made sticky based on how well it is answered.

All the best :)

Answer 2

Squre off means closing the position by reverse action.

If bought then sell,

Exersize is implementing youe action.

Generaly excercize is tedious , time conzuming and good for futures and not for options.

Most of the options (99%) are squred off!

Answer 3

The term "square off" means booking profit/loss on ur holding derivative position at any time before expiry....This is not done from the exchange or any other person apart from either ur broking house on ur behalf or himself by u.....

The term "Exercise" means that u are holding a derivative position and its still open......the seller of the derivative contract has however, have the power to exercise or square off the trade at any time( only on stock derivatives) and if he/she exercise the position then ur holding same position will also get automatically gets square off and the contract between both of u will come to an end. ......

Again, this exercise is not allowed on index based derivative position, as the same is excersied by the exchange itself only after the expiry of the contract......

Answer 4

Just to give you a short answer. Squaring off means closing out the option position by selling what you previously bought or buying back what you previously sold. It's like selling the stock to bought earlier or buying back the stock you shorted earlier.

Exercising an option means taking/making delivery of the underlying instrument. E.g. if you buy a call option then you have the right to buy the underlying instrument (e.g. a stock) at the exercise price. So if you exercise the option you exercise the right the option gives you, in the above case you would buy the stock at the strike (aka exercise) price.