I put these notes together, would appreciate some feedback on accuracy of statements and rationale. Call & Put Options on FUTURES: American worth more than European (because changing futures prices make it valuable to be able to call early) Call & Put Options on FORWARDS: American equal to European (because forward prices do not change so there is no value to exercise early) Call & Put Options on NON-DIVIDEND paying stocks: American equal to European (because in absence of a dividend which decreases the value of a call and increases the value of a put, there is no benefit of exercising early) Call & Put Options on DIVIDEND paying stocks: For calls, American worth more than European (dividend decreases the value of the call, so there is value in being able to exercise just before the ex-dividend date). Here is my question. —>> For puts, there is no benefit of exercising early (so American = European). My reasoning is that dividends will increase the value of the put, so there is no use of exercising just before the ex-dividend date. The exception is if the American Put is deep in the money in which case American can be worth more than European (I recall reading this somewhere). Can someone with a good grasp on this comment on the accuracy of all of the above, particularly on the last part (on puts on non-dividend paying stocks). I realize that some of this stuff conflicts with real life info but we have to learn this the way CFAI believes it is so so it is hard to find an answer online that matches what CFAI says. Thanks.
> Call & Put Options on FUTURES: American worth more > than European (because changing futures prices > make it valuable to be able to call early) > DEEP in the money Call & Put Options on FUTURES: American worth more Reason: By exercising you have access to the underlying cash flow of mark-to-market. http://www.analystforum.com/phorums/read.php?11,1086215,1086249#msg-1086249 > Call & Put Options on FORWARDS: American equal to > European (because forward prices do not change so > there is no value to exercise early) > correct, but the reason is again there is no mark-to-market cash flow which you can use. > Call & Put Options on NON-DIVIDEND paying stocks: > American equal to European (because in absence of > a dividend which decreases the value of a call and > increases the value of a put, there is no benefit > of exercising early) > correct, but for a put you don’t have a benefit of dividend anyway since you are short so you have to pay dividend. > > > Call & Put Options on DIVIDEND paying stocks: For > calls, American worth more than European (dividend > decreases the value of the call, so there is value > in being able to exercise just before the > ex-dividend date). > DEEP IN THE MONEY CALL only since you have access to dividend which you can invest elsewhere giving return better than cost of borrowing you incur to exercise the deep-in-the money call (borrow strike price- option value) and in addition, same pay off as holding option (delta =1). Not applying for put since you have to pay counterpart dividend, thus American put will have same value. See also http://www.analystforum.com/phorums/read.php?12,1094136,1094520#msg-1094520 > The exception is if the American Put is deep in > the money in which case American can be worth more > than European (I recall reading this somewhere). > Wrong. See above. > > Can someone with a good grasp on this comment on > the accuracy of all of the above, particularly on > the last part (on puts on non-dividend paying > stocks). I realize that some of this stuff > conflicts with real life info but we have to learn > this the way CFAI believes it is so so it is hard > to find an answer online that matches what CFAI > says. Thanks. No conflict with real life. Not CFA way only neither. Widely explained in standard derivative books. John Hull,…
> > Call & Put Options on NON-DIVIDEND paying > stocks: > > American equal to European (because in absence > of > > a dividend which decreases the value of a call > and > > increases the value of a put, there is no > benefit > > of exercising early) > > > > correct, but for a put you don’t have a benefit of > dividend anyway since you are short so you have to > pay dividend. > > > > > > > Call & Put Options on DIVIDEND paying stocks: > For > > calls, American worth more than European > (dividend > > decreases the value of the call, so there is > value > > in being able to exercise just before the > > ex-dividend date). > > > DEEP IN THE MONEY CALL only since you have access > to dividend which you can invest elsewhere giving > return better than cost of borrowing you incur to > exercise the deep-in-the money call (borrow strike > price- option value) and in addition, same pay off > as holding option (delta =1). > > Not applying for put since you have to pay > counterpart dividend, thus American put will have > same value. > > See also > http://www.analystforum.com/phorums/read.php?12,10 > 94136,1094520#msg-1094520 > > > > The exception is if the American Put is deep in > > the money in which case American can be worth > more > > than European (I recall reading this > somewhere). > > > Wrong. See above. > > rechecking my notes. I was wrong on some points: 1- American call is worth more on dividend paying stocks, INDEPENDENT whether it is deep on the money or not. The argument is the same as explained earlier. 2. American put is worth more than European put on stocks, if deep on the money. Take an (extreme) example. Strike price 20, stock price nearly 0 --> exercising now, you can get 20 now. If you want, the stock may go up then your profit will no longer be 20. The reason is stock price can never below 0, so there is a cap on the potential profit. The points about futures are still correct: DEEP in the money Call & Put Options on FUTURES: American worth more Call & Put Options on FORWARDS: American worth same.
I agree with elcfa’s second post.
- Non Dividend Paying Stocks: American = European 2. Dividend paying stocks: American call > European Call; American put > European put IF deep in the money. 3. Call & Put Options on FUTURES: American > European IF DEEP IN THE MONEY 4. Call & Put Options on FORWARDS: American = European
- Non Dividend Paying Stocks: American call = European call ;American put > European put IF deep in the money. 2. Dividend paying stocks: American call > European Call; American put > European put IF deep in the money. 3. Call & Put Options on FUTURES: American > European IF DEEP IN THE MONEY 4. Call & Put Options on FORWARDS: American = European
thanks a lot elcfa
For Call & Put Options on FUTURES: American > European IF DEEP IN THE MONEY but if on or out of the money, American = European?
joseph213 Wrote: ------------------------------------------------------- > For Call & Put Options on FUTURES: American > > European IF DEEP IN THE MONEY but if on or out of > the money, American = European? Correct
I know the rationale is that American & European call options on forwards have the same value due to the lack of mark to market cashflows, but something is bugging me here. Regardless of the cashflows, surely the American option should be worth more as you have the ability to grab the profit as it moves in the money, whereas with the European option, you do not have this ability, and the value may move out of the money again by the exercise date. I would expect that this additional flexibility would have *some* worth that nudged the American value above the European value. I’ve probably missed something, so any help appreciated. Thanks.
Ahhhh… Is it because forwards can’t actually be exercised until the agreed date? /idiot