This is probably one of the top three or four questions I get: when can early exercise (exercise before expiration Friday) of call options be predicted to occur? Of course, only calls that are in the money (ITM) will be exercised early - meaning the stock price is higher than the calls’ strike price.

ITM calls are as a general rule are only exercised early when expiration draws close and they are trading at or below parity - “parity” means that an option is trading exactly at intrinsic value with no time value at all. This generally happens in the last week or possibly two weeks before expiration; usually in the last few days. When there is time value left in the calls, it is more profitable to flip the calls than to exercise them and sell the stock. When the call’s price is below parity, exercise can be expected, and the further below parity the more likely exercise becomes.

Thus I don’t worry about early exercise until an ITM call gets close to or at parity. Even when parity is reached, though, the covered call writer has the option to close the call or to roll out a month (or up and out) to get more premium or avoid losing the stock, if desired. Covered call writers have a lot of say in whether they are called out or not.

Still, early exercise of ITM calls is never assured even when calls are trading below parity. But if open interest in the calls is high (meaning a lot of professional traders) when this occurs, exercise is quite likely.

This entry was posted on Friday, April 20th, 2007 at 1:53 pm and is filed under Covered Calls, Trading Tips. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.