Early Exercise of Options: When and Why It Happens

Most options are not exercised until expiration, but early exercise does happen and can catch option sellers off guard. Understanding when and why someone might exercise an option early helps you manage your positions and avoid surprises. This guide covers everything you need to know about early exercise.

What is Early Exercise?

Early exercise occurs when an option holder chooses to exercise their option before the expiration date. This is only possible with American-style options, which include most stock and ETF options traded in the United States.

Why Would Someone Exercise Early?

In most cases, selling an option is more profitable than exercising it because you capture both intrinsic and extrinsic value. However, there are specific situations where early exercise makes sense:

1. To Capture Dividends

This is the most common reason for early exercise of call options. If a stock pays a dividend, call holders might exercise the day before the ex-dividend date to own the shares and receive the dividend.

2. Deep In-The-Money Puts

When a put is deep ITM, the holder might exercise early to receive cash now rather than waiting until expiration. The interest that can be earned on that cash sometimes exceeds the remaining time value of the put.

3. Minimal Time Value Remaining

When an option has almost no extrinsic value left, there is little reason to wait. The option holder might exercise to avoid the risk of the stock moving against them before expiration.

4. To Take a Stock Position

Sometimes a trader simply wants to own the stock (or short it) and exercising their option is a convenient way to establish the position.

Early Exercise of Call Options

For call options, early exercise is primarily about dividends. Here is when to watch out:

The Dividend Decision

A call holder will likely exercise early when:

• The option is in-the-money
• The dividend amount exceeds the remaining time value
• The ex-dividend date is the next trading day

How to Protect Yourself

• Know the ex-dividend dates for stocks you trade
• Close or roll ITM calls before the ex-dividend date
• Factor dividends into your covered call strategy
• Consider selling OTM calls that are less likely to be exercised

Early Exercise of Put Options

Put options are less commonly exercised early, but it does happen in specific situations:

When It Happens

• Deep ITM puts: When the put is so far ITM that time value is negligible
• Interest rate consideration: Exercising provides cash that can earn interest
• Near expiration: When only a few days remain and the put is ITM
• Stock at zero or near zero: If the company is bankrupt, there is no reason to wait

How Early Assignment Affects You

If someone exercises their option early, you (as the seller) may be assigned. Here is what happens:

Call Assignment

• You must deliver 100 shares per contract at the strike price
• If you own the shares (covered call), they are sold from your account
• If you do not own shares (naked call), you will be short the stock

Put Assignment

• You must buy 100 shares per contract at the strike price
• Cash or margin is required to purchase the shares
• You now own stock that may be worth less than you paid

Why Early Exercise is Often Suboptimal

Despite the situations described above, early exercise is usually not the best choice for option holders. Here is why:

• Time value is forfeited: By exercising, you give up any remaining extrinsic value
• Commission costs: Exercising and then selling stock costs more than selling the option
• Capital efficiency: Holding an option requires less capital than owning stock
• Flexibility: Options can be closed at any time; stock positions are less flexible

Probability of Early Exercise

Here is a general guide to early exercise probability:

High Probability

• ITM calls the day before ex-dividend (when dividend exceeds time value)
• Deep ITM options with less than 1 week to expiration
• Options with essentially zero time value

Low Probability

• OTM options (no intrinsic value to capture)
• Options with significant time value remaining
• Non-dividend-paying stocks (for calls)
• Options with many weeks until expiration

Strategies to Manage Early Exercise Risk

As an option seller, here is how to manage the risk of early assignment:

• Monitor dividend dates: Know when dividends are paid for stocks you trade
• Watch time value: If your short option's time value drops near zero, consider closing
• Use spreads: Having a long option protects you if your short option is assigned
• Roll before ex-dividend: Move ITM calls to later expiration before dividend capture
• Trade European-style options: Index options like SPX cannot be exercised early

Early Exercise and Spreads

If you trade spreads and one leg is assigned early, you still have protection from your long option. However, you need to manage the position:

Summary

Early exercise is relatively rare but does happen, especially around dividend dates and when options are deep in-the-money. Understanding the mechanics helps you protect your positions and avoid surprises. Remember that dividends are the main driver of early call exercise, deep ITM puts with minimal time value may be exercised early, and using spreads provides protection if one leg is assigned.

Want to learn more? Check out our guide on options assignment or learn about what happens at expiration.