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What is a Cashless Exercise?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 27 September 2016
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    Conjecture Corporation
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Cashless exercises are an investment strategy that involves the conversion of various types of options into stock. The beauty of a cashless exercise is that the method does not require the investment of an initial cash disbursement to cover the strike price. To a degree, the use of a cashless exercise is somewhat like that of buying on margin, although the repayment to the broker occurs much quickly.

Making use of a cash exercise is not a difficult process, especially for investors who have a solid rapport with a broker. After identifying a stock that the investor wishes to purchase, the broker will briefly loan the investor enough funds to cover the initial cash payment required to secure the stock. After the stock is secured, a small portion is quickly sold and the proceeds are used to repay the broker. The investor retains control of the remaining stock gained from the purchase.

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A cashless exercise is often a quick and easy way to secure desirable stocks. Since the process does not involve a need for either the investor or the broker to contact a third party for financing, the actual execution of the exercise can move along at an expedited pace. Depending on the strength of the relationship that exists between the investor and the broker, the investor may be allowed to hold all acquired shares for a short period, in order to maximize the amount of return from the investment. This may result in the need to sell off fewer shares if the stock undergoes a specific rise in value over a short term.

Fortunately, converting options into stock is a process that is well understood by most brokers. When the process of a cashless exercise is utilized with a well established and ethical client, the broker can benefit it two ways. First, the loan is considered to be very secure, since the investor is certain to repay the balance due. Second, the cashless exercise helps the broker to strengthen the rapport with the client. This will mean the continuance of commissions generated by the investor, which translates into continued revenue for the broker.

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