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Most options traders sell their call options early instead of exercising them, as you would make a bigger profit this way due to being able to salvage some remaining extrinsic value.

For example:

You bought one contract of $\$10$ strike price call options on $XYZ$ stock for $\$1.00$ when $XYZ$ was trading at $\$10$. Assuming $XYZ$ rises to $\$12$ prior to expiration of the $\$10$ strike price call options and the call options are now worth $\$2.10$.

Scenario 1: Exercise the Call Options

By exercising the call options, the call options cease to exist and you bought $XYZ$ stock at $\$10$. You can now sell those $XYZ$ stocks immediately for its market price of $\$12$ to make a gain of $\$2 - \$1.00$ (price you paid the call options for) = $\$1.00$.

Scenario 2: Selling the Call Options

You simply sell your call options at its market price of $\$2.10$ and make a profit of $\$1.10$. As you can see above, selling the call options allows you to salvage that remaining $\$0.10$ of extrinsic value while exercising the call options won't.

I have one follow up question based on this scenario:

By selling (writing) the call before expiration and salvaging the remaining $\$0.10$ of extrinsic value, would you not be exposing yourself to risk?

Imagine if the underlying stock were to continue to rise above $\$12$ prior to expiration of the $\$10$ strike price. Then you (as the call writer) would be obligated to sell the underlying at $\$10$ if the buyer of the call were to exercise the option. If the underlying has now risen to $\$14$ prior to expiration then you would be loosing $\$14-\$10=\$4$ upon the buyer exercising.

This seems to be a reason that you may desire to exercise early and take a guaranteed profit rather than expose yourself to risk if the stock continues to rise before expiration. What would be the best way to mitigate this risk?

Let me know if my logic is flawed on this conclusion.

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I don't understand. You are selling the call option you currently own, so you are left with nothing. At no point are you naked short the call option.

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  • $\begingroup$ Wouldn't selling the call option without owning any of the underlying stock put you short on the call? - Source: investopedia.com/articles/optioninvestor/122701.asp $\endgroup$ – Wayne Dec 11 '15 at 23:17
  • $\begingroup$ No. Step 1, you buy the option, you are now long 1 option. Step 2 you sell the option, now you have nothing. you are not short anything. You have just gone back to the status quo. $\endgroup$ – Alex C Dec 12 '15 at 4:52
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Just think like this :

You bought one call option at $\$1$ (Long Position)

You sold one call option at $\$2.10$ (short Position)

Both contracts have same maturity and strike price. In this case, gain from Long Position will be cancel out from the loss in short position at the maturity or vice versa such that total pay-off from both the contract would be zero.

In this way by selling a call option(already having long position in call) you would left with nothing.

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