Early exercise of American options can generate gains when they are “deep in-the-money”, but what if they are not “deep” but just in-the-money?
You wont gain much since you have to cover the cost of the option, taxes etc.
What you are saying is true for American CALL Options. When you exercise a Call option, you buy the underlying by spending Cash. That is, by exercising that call option, you are foregoing any risk-free interest you would earn on that cash. So, if call option is deep-in-money, then profits from exercising that option will far outweigh the loss of risk-free interest. But for not-so-much-deep-in-money call options, those profits may or may not outweigh loss of foregone interest on your Cash.
This is only for call options on futures b/c there is no money that switches hands at the beg. of a futures contract AND they are marked to market every day. B/c the call option costs the investor has their cash tied up in the call. if it is exercised then the investor gets their back and can invest it in the futures margin account.
And call options on equity…
Yes, but not for any equity though, only those that produce sufficient cash flows… for Am. Call options on assets that make no cash pmts there is no reason to exercise an Am. call early. so you could say this applies to equity with suffuciently large divs in the near term, and FI products with suffieciently large coupons nearing payment, and anything paying out CF’s - but that is not included in the text b/c it is a specialist topic. Though it’s obvious the decision of whether to exercise or not. as long as CF/(1+r)^tcf > [S-x/(1-r)^texp] - [S-x] then excersize (where tcf = time to cash flow and texp = time to exp of option. however that won’t be on level II. The “Deep in the money” reference at the begining of this thread is in regards to futures though, b/c you need to tie up $ in the Futures margin account. otherwise the decision is just based on the CF and its timing.