Stock options should never be exercised before they expire. If someone wants to lock in gains on their stock options and can’t sell them (for example if they’re employee stock options), they should short the company’s stock, and exercise their stock options when they are about to expire to cover the short positions. There is no additional risk since any potential loss on the short positions would be balanced by the gain on the stock options. But there are two benefits. First is the interest on the strike value of the stock options. Second is the potential gain if the market price were to fall below the strike price. Here’s an example to make things clear. Suppose Alice holds options to buy 100 shares of XYZ at $10 and the current market price for XYZ is $20. If she was to exercis…
Stock options should never be exercised before they expire. If someone wants to lock in gains on their stock options and can’t sell them (for example if they’re employee stock options), they should short the company’s stock, and exercise their stock options when they are about to expire to cover the short positions. There is no additional risk since any potential loss on the short positions would be balanced by the gain on the stock options. But there are two benefits. First is the interest on the strike value of the stock options. Second is the potential gain if the market price were to fall below the strike price. Here’s an example to make things clear. Suppose Alice holds options to buy 100 shares of XYZ at $10 and the current market price for XYZ is $20. If she was to exercise her options she would get (20-10)*100 = $1000. Suppose that instead she shorts 100 shares of XYZ now and exercises her options five year later to cover the short, when XYZ rises to $50. She would get $2000 now and pay $1000 five year later. This is equivalent to $1216.47 today because she can put $783.53 in a bank account yielding 5% and five years later it will turn into $1000. If five years later XYZ drops to $5 instead, Alice would only have to pay $500 to cover her short and her gain is even larger. So no matter what happens Alice gets at least an extra $216.47, possibly more.