How to Exercise a Stock Option
Stock options are a popular way of leveraging stock investments. Your stock options may be negotiable (the types traded on exchanges like the Chicago Board of Options Exchange) or employee stock options (ESO) provided by your employer as an incentive. All options entitle you to buy (or sell, for negotiable "put" options) shares at a set price, called the "strike price," until the date the option expires. If a stock goes up in price, you can buy the stock below the new market price. That's called exercising the option.
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Instructions
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Prepare ahead of time to exercise negotiable stock options. Trading these listed options profitably often depends on being able to quickly exercise the option when the price reaches your target. If you use an online broker, choose one who allows you to enter the order electronically and have it executed immediately. Alternatively, make sure your broker will agree to exercise an option automatically at a predetermined price to protect your profits.
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Arrange with your broker to execute a cashless option exercise. When you exercise any option, you must put up the strike price to buy the stock and then sell the stock to collect your profit. A cashless exercise avoids this. For a small fee, your broker will loan you the money so you don't have to come up with the cash yourself. The loan is repaid as soon as the stock is sold (usually the same day).
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Exercise employee stock options the same way. The primary difference when you exercise an ESO is that you must deliver the option to your broker unless you are using the same firm as your employer. In addition, because ESOs are long term (typically several years), it's rarely necessary to put fast execution as a priority. Profit on ESOs depends mainly on long-term appreciation of the stock, not on short-term market fluctuations.
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Check to see if your ESO allows reloads. In a reload ESO, your employer will issue a new stock option to replace the one you have exercised up until the expiration date. The reload option has a new strike price set at the current market price of the stock. This allows you to take profits already gained and to make more money on the ESO if the stock continues to appreciate.
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Tips & Warnings
Employee stock options usually carry no downside risk because employers provide the options at their expense. That's not the case with negotiable options you purchase. Your downside risk is limited to what you pay for the option. However, you can lose all of the money you invest if the stock price doesn't move enough to put you "in the money" before the option expires. You should watch the trading behavior of the underlying stock carefully and be prepared to exercise the option on short notice.
