Do You Need Money to Buy the Shares When Executing a Call Option?
Call options are contracts that give you the right to buy a specified amount of an underlying security such as a stock at a guaranteed exercise price. If the value of the stock goes up before the options’ expiration date, you can exercise your options to buy the shares at the lower exercise price. If the price doesn’t increase, you simply let the options expire. In most cases you do not need money to buy the shares when exercising a call option.
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Exercise Basics
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When you exercise a call option, you must pay the writer (issuer) of the option contract the specified exercise price. For example, if you exercise an option to buy 100 shares of company A for $50 per share, you pay the option writer $5,000. Let’s say the market price on the day of exercise is $70 per share. The proceeds from the sale cover the exercise price plus $2,000 gross profit. Your net profit is the gross profit minus brokerage fees and the premium you paid to purchase the call option contract.
Settlement Types
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There are two methods of executing an option exercise. Some types of options, such as index options, are settled for cash. With cash settlement, you don’t actually buy the underlying security. Instead, the difference between the market value and the exercise price at the time of exercise is simply credited to you account. The other method is physical settlement, meaning you must actually buy the underlying security from the option writer. Call stock options require physical settlement.
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Stock Option Settlement
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Brokerage firms require you to have the funds needed to cover any purchases you make in your account by the “settlement date.” If the money to buy shares isn’t in your account when you place a buy order, you have a day or two to deposit sufficient funds. Suppose you tell your broker you want to exercise a call option and buy the shares. If you place an order to sell the shares the same day, your broker knows the sale proceeds will be credited to your account by the settlement date. The end result is that you don’t need money to exercise your call option contract. However, brokers are strict about exercising options. In general, if you don’t sell the shares the same day, the funds to buy the shares must already be in your account when you exercise the option.
Employee Stock Options
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Employee stock options are a special form of stock option employers award to employees. There are two types for employee stock options: incentive and nonqualified. The rues for incentive stock options require you to hold the shares for a year after the exercise date, so normally you must actually have the cash to pay the exercise price. Nonqualified stock options may be sold immediately. Usually this is done in the form of a “cashless exercise.” You take the options to your broker, who loans you the money to pay the exercise price. Your broker then sells the shares, deducts the loaned money from the sale proceeds and deposits the remainder to your account. In this way, you don’t need any cash to exercise nonqualified stock options.
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