Suppose i buy a ed call option with a delta of .5 at a price of 99.50. Now say prices rise one basic point in my favor. I would only make $12.50 by selling the option. At the same time I think exercise the call option at 99.50 and immediately sell a ed future at 99.51 to lock in the entire $25. Yet from my understanding i should be indifferent to whether i exercise or not. Should the values not be equal? What am i missing? Your help is greatly appreciated. Thank you.
Ignoring everything else that may happen to your option position when the mkt moves, let's look at your question simplistically. When you exercise your call option, you're effectively selling the option for 0 and buying the underlying at the strike price of 99.50. So what you're missing is the negative pnl on the option leg of the exercise. Moreover, any such pnl calculations should include the premium you have paid for the call option in the first place. Once you include that, you're including the whole consideration of time value vs cost of carry, which is what the suboptimality of early exercise is all about.
I'd say you are confused about options in general, not just about eurodollars. Your logic is flawed no matter which underlying you use.
Use the attached spreadsheet and chart the payoff function and break even points.....this should help you.
I did not include cost of carry because it didnot effect my out come. Which was early exercising and then offsetting with an opposite position seemed to be more profitable than selling. Lets say i buy an ed call at 99.25 for $700 and libor is at 99.50. Now prices go up to 99.75. If i exercise i would recieve $1250 when marked to market(50x25=1250-700cost=$550). Would this $550 not be more than if I had sold the option outright? I am getting less than a 1 for 1 move on the underlying at purchase and the theta is only 3 ticks. $625 intrinsic value and $75 time value. I apologize if i am boring those of you who are familiar with options with my novist questions.
I think you have pretty much answered your own questions, no? Assuming you're looking at the two alternatives at the exact same time, what do you think you would receive if you sold the option, rather than early exercising?
I see my error now. I assumed the option would yield less because of the lower delta than the underlying but i have money invested in time value. Once the option starts trading at intrinsic value both deltas would be at 1. So they are equivalent. Thank you for your help.