What is meant by exercising an stock option?

Question

what is meant by exercising an stock option?

Answer 1

You have an option to do something or not to do it. Exercising is doing it. Lets say you have paid £10 for the option to buy 100 shares at £1 each. You have paid the £10. If you lapse the option (do nothing) you lose the £10. If you exercise the option you pay the extra £1 per share and 'buy' thoses shares. So they have cost you £110 or 110p each. An option is basically a choice. I have the option to eat today or not, whatever.

Answer 2

You are "exercising" your right (but not obligation) to sell at the current market price.  

Answer 3

Let's say you are in a startup that goes public and the shares sell at $10/share. Maybe the caompany can't pay you a huge salary but they give you contracts with a "strike" price of $15. If you "exercise" these options, then you can buy stock shares at $15, no matter what the market price of the stock is. Option contracts usually represent 100 shares.

So if the stock goes to $20, then you can exercise your options and buy the shares for $15 and make a instant $5 profit. If the stock goes to $25, then you make a profit of $10/share.

Answer 4

There are two ways stock option contracts are created. An option contract can be created by a buyer and a seller agreeing on a premium which the buyer pays to the seller. Contracts like this are traded on exchanges, such as the Chicago Board Option Exchange. There are two types of exchange traded options, calls and puts. A call option gives the buyer the right, but not the obligation, to purchase the underlying for for a set price (known as the strike price) for a set time period. A put option gives the buyer the right, but not the obligation, to sell the underlying for for a set price (again, known as the strike price) for a set time period. For an exchange traded stock option in the United States, "the underlying" is 100 shares of stock. If the buyer decides to trade the stock by using the option, that is called exercising the option. When the buyer exercises the option the person that sold the option is required to take the other side of the trade.

An stock option contract can also be created by a company issuing an option to an employee. Such contracts are part of the employees compensation contract and are not traded on exchanges. The are always call options. If the employee decides to buy the stock by using the option, that is called exercising the option. When the employee exercises the option the shares given to him by the company in return for a payment per share equal to the stirke price..

The answer that you received from "efflandt" assumes you are talking about exchange-traded options and is correct except that an option does not have to be in the money to be exercised.

The answer you received from "Paul" assumes you are talking about company issued employee stock options. I agree with the first part of his answer, but I think it is misleading to say "So if the stock goes to $20, then you can exercise your options and buy the shares for $15 and make a instant $5 profit." In order to exercise the option you had to already own it, and if the stock was selling for $20 per share the option had an intrinsic value of $5.00 per share, which in turn means you had an unrealized gain of $5.00 per share on the option before you exercised it. When you exercised it you buy at stock worth $20 per share for $15 per share, so you have simply converted an unrealized gain that you already had on the option into an unrealized gain on the stock.

I agree with the answer you got from "Heather" is accurate but I do not think it answered your quesiton.

All of this may be a little difficult to grasp if you don't really understand options. If you are interested, it might help to take the "Options Overview" tutorial at

http://www.cboe.com/LearnCenter/Tutorial...

Answer 5

You would exercise a stock option because you do not have to. You have the option to let the contract expire and do nothing else.

Answer 6

It means that if the strike price of the option is in the money, and you are long the option (bought it)

1. If it is a call, you can buy the stock by paying the strike price (exercising the option) plus whatever fee your broker charges for that.

2. If it is a put, you can sell the stock at the strike price, minus broker fee.

Similarly someone else exercises an option your are short (you sold it), you could be forced to give up your stock for the strike price if it is an in the money call, or forced to buy it at the strike if it is an in the money put.

Any american style option can be exercised any time it is in the money before or at expiration.  European style options are only exercised if in the money at expiration.