What it Means to Exercise an Option? An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying security at a specified price on or before an expiration date.
If the option buyer decides to buy or sell the underlying security, rather than letting the option contract expire, then he is exercising the option.
The buyer of a call option may exercise his right to buy the underlying security at the specified price. The buyer of a put option may exercise his right to sell the underlying security at the specified price.
If the buyer of an option does exercise his right, then the option seller, who is known as the option writer, is obligated to fulfill the terms of the option contract. If it is a call option, the option writer is obligated to sell the underlying security at the strike price to the option buyer. If it is a put option, the option writer is obligated to buy the underlying security at the strike price from the option buyer. Just to reiterate this point, the option writer is not obligated option prices in models fulfill the terms of the option contract unless the contract is exercised by the option buyer.
The buyer has the right to exercise his option but does not obligated to do so. The call option at this point should be exercised. Assume an investor owns one put option for IBM.
The put option at this point should be exercised. After having read this article, investors now know what it means to exercise an option. Investors also should have gained an idea of the best time to exercise their options to earn maximum profit.