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Exiting an Option Position
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There are several ways one can exit or close an option position. The first (and easiest) way is to sell back the option position on the open market, provided the option still has some value. If the option has no value it will expire worthless and there is no need to exit the position. Selling back a long option position works much like selling back a long stock position. It is sold at the best available bid price.
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The other way a long option position can be closed is by exercising the option. Exercising an option is the right of the option buyer, not the option writer. One would only want to exercise an option if there was intrinsic value and the majority of the time value had decayed. Exercising an option with time value decay would mean the option owner is forfeiting this additional premium when he could realize it as additional profit if he were to sell back the option position on the open market.
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One would only exercise a call option if the stock price was above the strike price he owns. When he exercises the option, he forces the option writer (seller) to sell him the said number of shares in the underlying stock at the strike price. If the option writer doesn't own these shares, he will have to purchase them on the open market at the current ask price and then deliver them to the option owner at the strike price. If the difference between the purchase price and the delivery price (strike price) is greater than the premium he received for writing the option, he will realize a loss.
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One would only exercise a put option if the stock price is below the strike price he owns. When he exercises the option, he forces the option writer to purchase from him the said number of shares in the underlying stock at the strike price. If the option owner doesn't own the shares in the underlying stock, he could either purchase them on the open market below where he owns the right to sell them and then exercise his option, or he could exercise his put option and sell the shares to the option writer and end up short the said number of shares at the strike price.
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An option will usually only be exercised on or near expiration due to the extrinsic value still left in the option premium. If the option owner exercises early, he forfeits the additional premium. Even though options are generally only exercised near expiration date, the possibility of early exercise always exists. If one is short an option, he would need to be aware of what action to take if assigned the position.
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