Function

• Options are often used to speculate on the price direction of the underlying stock. Whether traders purchase call or put options depends upon their price expectations. Those expecting the underlying stock to rise buy calls. Those anticipating a stock's decline buy puts.
  
  

Effects

• Deciding whether to trade or exercise an option is often easy. If an option is profitable, a trader may want to sell. Determine option profit by subtracting the purchase price from the price at which the option may be sold in the market now. Apply commission charges to calculate net profit.
  
  

Time Frame

• Deciding whether to trade an option into the open market or exercise may also depend on its expiration date. An XYZ 40 call expires on December 10. XYZ trades at 45 on November 10. Since the option is in-the-money, the trader may decide to sell the option before it loses time value. An option has both time value and intrinsic value. Time value erodes as the option approaches expiration.
  
  If your option is profitable but close to expiration, exercise may be necessary. Few people want to purchase an option's contract without time value. According to Bodie, Kane and Marcus in "Investments," exercise may be the only way to capture unrealized gains.
  
  

Considerations

• Some options, referred to as out-of-the-money, trade at low values in the open market. The underlying stock of an out-of-the-money option has moved in the opposite price direction of the strike price. For example, the underlying stock of an out-of-the-money call option has moved lower than the strike price. Anyone can purchase the shares at a lower cost than the strike price, so the option has little or no intrinsic value. The underlying stock of an out-of-the-money put has moved higher than the strike price. Because anyone may sell shares at a higher price in the open market than the strike price, the put's value is small or nonexistent. A trader in either situation usually allows the option to expire worthless.
  
  

Benefits

• When the underlying stock moves according to expectations, exercising an option to own stock may be a good decision. The stock option will expire by a certain date at no value unless traded or exercised. Ownership of the stock provides unlimited time for the stock to appreciate. Long-term gains apply to stocks held more than one year and one day and receive favorable tax treatment.
  
  

Potential

• The cost of owning stock, versus an option's cost, may also determine whether to exercise or sell the option. According to "Trade Options Online," last-minute exercise makes sense when a stock pays no dividend and is purchased on margin. When the underlying stock pays an attractive dividend and the call option is profitable, early exercise may make sense.