Hi all, I thought american call options is more valuable than european. Can some explain when they are not or how does the value of american/euproean call changes over the time. Thanks
the possibility of early exercise is not valuable on a call on a non-dividend paying stock. in that case, values of american option = european option.
bobsters Wrote: ------------------------------------------------------- > the possibility of early exercise is not valuable > on a call on a non-dividend paying stock. in that > case, values of american option = european option. Hi bobster, Can you please explain this- ‘the possibility of early exercise is not valuable on a call on a non-dividend paying stock’. And will it change if the option is deep in the money?
price of american is always >= price of european. # For an American-style call option, early exercise is a consideration whenever the benefits of being long the underlier outweigh the costs of surrendering the option early. For instance, on the day before an ex-dividend date, it may make sense to exercise an equity call option early in order to collect the dividend. In general, equity call options should only be exercised early on the day before an ex-dividend date, and then only for deep in-the-money options. # For an American-style put option, early exercise is a consideration for deep in-the-money options. In this case, it can make sense to exercise early to be short the stock, and therefore collect short interest from the short stock position. In general, this makes most sense for underliers that don’t pay dividends, and are not difficult to borrow. Ex-dividend dates are generally not a concern for determining when to exercise a put option early.
OK, can you have a look at Schweser exam 3, PM, Q100 in this aspect? Many thanks
It is a non-dividend paying stock, in that case the value of AO and EO is same, so the difference is 0. Ans B
But the option is in the money?
Is this in the syllabus?
solarpower03 Wrote: ------------------------------------------------------- > But the option is in the money? Dude… just read what is said before you. The value of an American style call option is exactly the same to an European call option IF there is no dividend. bobsters explained why perfectly.
> you. The value of an American style call option is exactly the same to an European call option IF there is no dividend I don’t know what the previous arguments are, but this is not true. Even if there is no dividends, a deep-in-the money European put does not alow you to exercise and lock in your profit, as you can with an American option.
Please read what I said. ‘American style call option’ Since for call options dividends are the key decider for early exercise. For put it’s the interest.
I see you are referring to calls only. After the exam, I will tell you that this dividend issue is not correct, i.e., no impact whether American or European, simply because market participants factor that in already…i.e., you gain nothing by exercising early. But for exam, it does make a difference.
What are you trying to say? That early exercise should never be done? It should. You are correct there is nothing to gain by early exercising early but there is something to loose if you don’t. A lot of profits have been made by this.
We’ll discuss post June 6.
Now I am curious. Hit me with your theory! (or practice) I actually do these things for a living so I should have some clue.
Stock trading today at $20 wil pay dividend of $1 after 5 months. A 6-month call with a strike of $25 is priced at $3 today. The stock price drops $1 next day dividend is paid, but the call option has been losing value for past few months in anticipation of the drop. If the stock price the day before dividend is paid (actually ex-div day), is (say) at $29. The call will not have a price of $4 ($29 - strike) because everyone knows that the price the next day will be $28. The call will be about $3. Anyone who exercises early must be a strong believer in inefficient markets.
I’m probably overlooking something but… If you exercise that day (when your call is worth $3 according to you) you exchange something that’s worth $3 for something that is intrinsically worth $4. Next day it goes ex-dividend, it will be worth $3 intrinsically but you received $1 in dividend. So by exercising you get $1 more. The call will be worth (approx.) $4 (slightly higher).
Something to think about after the exam: (1) Why would anyone pay $4 for the call on the day before ex-div when they know for a fact that the stock price will go down by $1next day, so that instead of being $4 in the money, tomorrow they will be $3 in the money, while at the same time they missed the dividend too? (2) If the dividend is relatively lare, the options exchange adjusts various things, including the strike price and or paying a cash difference, etc.
- You exercise early. That’s why it’s valued at $4. If you don’t you indeed loose money. Pricing wise you price in the early exercise effect in the binomial tree. 2) That’s when dividend > 10% (yield wise).