Profiting Bigger The graph to the right shows the price of XYZ stock increasing from $37.50 in the left graph, to $39.00 in the right graph. In this case, XYZ stock has gone up above the exercise break-even point of $38.50, allowing you to exercise the call profitably. Would it now be better to exercise the option as opposed to selling it? Not a chance!
If we sell the call, we make an $0.80 profit because we paid $3.50 for the option and we sell it for it's current price of $4.30.
If we were to exercise the option, the outcome is not as good. The exercise break-even was $38.50 (left graph). By exercising the option when the stock price is at $39.00 (right graph), we would acquire the stock for a total cost of $38.50 per share. To get our profit, we immediately sell the stock for the current market price of $39.00. The profit is $39.00 - $38.50, which is $0.50.
It's a no-brainer. It is always more profitable for us to sell options outright as opposed to exercising them. But why? The reason is because whenever you exercise an option, you forfeit any remaining time value the option has. Looking at the graphs above, the time value is the red portion. You are giving that a way when you exercise. To whom are you giving it? To the person on the other side of the trade: the short seller of the option! In contrast, when you sell the option, you get paid the full price of the option, which includes any time value.
