Early Exercise: When to Exercise Options Before Expiration

Most people think of options as something you hold until expiration and then decide whether to cash in or let it go. But there’s a powerful, often misunderstood move you can make before that final date: early exercise. It’s not something you do lightly - in fact, for most retail traders, it’s a mistake. But for certain situations, especially with employee stock options or dividend-paying stocks, exercising early can save you thousands in taxes or lock in profits you’d otherwise lose. Here’s when it actually makes sense - and when it’s a costly blunder.

Not All Options Are Created Equal

The first thing you need to know is that not every option lets you exercise early. American-style options - the kind tied to individual stocks and ETFs - give you the right to buy or sell the underlying asset anytime before expiration. European-style options, which mostly apply to index options like the SPX, can only be exercised on the expiration date. So if you’re trading Apple, Tesla, or an S&P 500 ETF, you’ve got flexibility. If you’re trading an index option, you don’t. This distinction alone changes how you think about timing.

Most retail traders never even consider early exercise. That’s because, in most cases, it’s a bad idea. Why? You’re throwing away time value. An option isn’t just worth its intrinsic value (the difference between the stock price and strike price). It also carries time value - the chance the stock moves further before expiration. If you exercise a deep in-the-money call early, you lose that remaining time value. The Options Industry Council found that 92% of early exercises on deep ITM calls result in unnecessary losses. You’re essentially paying to close a position you could’ve sold for more.

When Early Exercise Makes Sense: Dividends

The one common scenario where early exercise actually adds value is when a stock is about to pay a dividend. Let’s say you own a call option on a company that’s going ex-dividend tomorrow. The stock price will drop by roughly the amount of the dividend when trading resumes. But if you exercise your call today, you’ll own the stock before the ex-date - and you’ll get the dividend payment. If that dividend is bigger than the time value left in your option, exercising early makes sense.

For example: You own a $50 call on a stock trading at $55. The option is worth $6. The stock pays a $0.80 dividend tomorrow. The time value in your option is $1 (the $6 price minus the $5 intrinsic value). Since the dividend ($0.80) is less than the time value ($1), exercising early costs you money. But if the dividend was $1.50, then you’d gain $0.70 by exercising - because you’re capturing more than what you’re losing in time value. This isn’t a strategy for casual traders. It’s a precise calculation professional traders use.

Employee Stock Options: The Real Goldmine

Where early exercise really shines is with private company stock options - especially at startups. Most employee stock option plans allow you to exercise before your shares fully vest. This isn’t a perk - it’s a tax hack.

Here’s how it works: When you exercise, you pay the strike price (say, $1 per share) to buy the stock. If you wait until vesting, you pay ordinary income tax on the difference between the strike price and the fair market value (FMV) at that time. But if you exercise early - even while unvested - and file an 83(b) election within 30 days, you lock in your tax basis at the $1 price. Then, any future appreciation is taxed as long-term capital gains, not ordinary income.

Let’s say you’re granted 10,000 shares at $1 each. The FMV is $2. If you wait until vesting, you owe tax on $10,000 of ordinary income. If you exercise now, file the 83(b), and hold for a year, you pay $0 in tax today (since FMV = strike price) and then pay 15-20% capital gains later when you sell. That’s a massive difference.

Carta’s 2023 data shows 67% of early exercisers cite tax benefits as their main reason. But here’s the catch: you have exactly 30 calendar days from the exercise date to file the 83(b) form with the IRS. Miss it by one day - and you lose the advantage. According to Carta, 12% of early exercisers miss this deadline. And if you’re in a high tax bracket, missing it could mean paying 37% instead of 20% on gains.

The Hidden Risks

Early exercise isn’t free. You have to pay for the shares. If you’re exercising 5,000 shares at $2 each, that’s $10,000 out of pocket. And if the company fails? You lose it all. CooleyGO’s 2022 survey found that 41% of early exercisers regretted the decision because their startup never had a liquidity event. The average unrecovered cost? $18,500 per person.

There’s also assignment risk if you’re short options. If you sold a call and the buyer exercises early, you’re forced to sell your shares - even if you didn’t want to. This is especially dangerous if you’re holding a covered call for income. A dividend-driven early exercise can trigger assignment and disrupt your strategy.

What About the Platform?

Exercising isn’t as simple as clicking a button. Most platforms still require you to email your broker. Public.com, for example, asks you to send an email with: your account number, the option symbol, strike price, expiration date, and exact quantity. Requests after 4 p.m. ET get processed the next business day. On expiration day, they’re handled immediately. And yes - you need to include the phrase: “I would like to exercise the following Options:”

Users report average processing times of 1.2 business days. Fidelity and Charles Schwab handle it faster, but the system is still clunky. That’s why Public.com is rolling out an in-app exercise feature in Q4 2024. Until then, if you’re planning to exercise, don’t wait until the last minute.

What’s the Big Picture?

Early exercise is not a strategy for the average trader. Most people should just sell their options instead. But for those with employee stock options - especially at early-stage companies - it’s one of the most powerful tax moves available. The math is simple: if the spread between strike price and FMV is small, and you believe in the company’s long-term future, exercising early and filing an 83(b) election can save tens of thousands.

For call options on dividend stocks, it’s a niche play. Only do it if the dividend exceeds the time value. For puts, early exercise is common among professionals holding deep ITM puts near expiration - it’s about locking in cash and avoiding assignment risk. But again, this isn’t something beginners should attempt.

The market is changing. In 2020, only 41% of Series A startups offered early exercise. Now, 63% do. And with platforms improving, adoption among retail investors is expected to rise 23% by 2026. But awareness is still low. FINRA data shows only 8.2% of eligible option holders ever exercise early. That’s because most don’t know it’s an option - or how dangerous it can be if done wrong.

Bottom Line

Don’t exercise early just because you can. Do it because you’ve done the math, understood the tax implications, and accepted the risk. For employee stock options: if the strike price is close to current value, file the 83(b) within 30 days. For dividend plays: calculate the dividend vs. time value. For everything else? Sell the option. Keep the time value. Let someone else take the risk.