mcf Wrote: ------------------------------------------------------- > Yes. American, always. European, not always. thanks mcf, I, too, feel desperate.
I think that the easiest intution here is this… If the price of a stock goes to $0, you would want to exercise immediately. However, with a European option, you can only exercise at maturity. Therefore, when the price hits $0, the shorter maturity option would be worth more because you could capture the maximum value sooner.
But only for the unusual stock price = 0 case …
Yes, but it shows that if there is one case where this is true, then the answer must be C
Not so - First, the question is equivalent to whether or not you should ever exercise an American put early towhich the answer is yes. This happens when the time value of money > time value of put. That will always be true at 0 but will be true at other prices as well. Whether or not you should exercise an American put is a quant question beyond the scope (btw - do you know that if an American put has an infinite expiration date there is a B-S like formula for its value?)
> This happens when the time value of money > time value of put So, you’re saying if you have $1000 tied in a put which is about to expire with interest rates say at 10%, that it might be worthwhile for you to take your money out by buying the underlying and selling it to the put writer, and then investing at the high interest rate. I’m sure you can set up a senario when this can make sense, but it would be unusal in practice, as there are transaction costs, etc. Right?
A put doesn’t necessarily cost much money to exercise. For a futures contract, it might be almost nothing -just the spread on the futures contract when you close it out. But, yeah, I’m saying that even with transactions costs there is some non-zero value (usually) at which you should exercise the put.
So Is it appropriate to apply put- call parity to make a conclusing on this question?? If so, I would go with A.
Nope - put-call parity doens’t mean everything true about calls is also true about puts.
Joey - without getting into a discussion about option theory and black scholes, I was trying to keep this relatively simple… Clearly we all agree that with a stock price that approaches 0, the value of the shorter time to expiration has a larger value than the longer time to exp. On the other hand, if the options are both far out of the money, the fact that options are worth more alive than dead, one could infer that the longer maturity put would be more valuable. As such, we can essentially eliminate answers A, B, and D. I don’t think we need to read too much into this question. Not sure which part of that argument you contend with, but I’m certainly open to your POV as well.
I don’t disagree with any of that. Hmmm… My “not so” above referred to Dreary’s post and we overlapped. Sorry about confusion.
Got it, no worries. After lurking on the website as I studied, I felt the need to start making some posts this weekend. Thanks for all of your insight.
I’m confused now… The original question was: Could the shorter maturity put ever be worth more than a long maturity put? 1) We said yes, for a European put since when the price hits zero, you can exercise and lock in the profit. 2) Then Joey said this doesn’t have to be only when stock price =0, as in when time-value of money > value of the put. But (2) above does not mean that shorter maturity put could be worth more than a long maturity put, that’s where the confusion is.
Dreary Wrote: ------------------------------------------------------- > I’m confused now… > > The original question was: Could the shorter > maturity put ever be worth more than a long > maturity put? > > 1) We said yes, for a European put since when the > price hits zero, you can exercise and lock in the > profit. > That is true. But maybe you should exercise for some value > 0. If the stock reached $0.01 and you had 20 puts that expire in a year, would you exercise? What about $0.02? What about $1? You might need a quant here. > > 2) Then Joey said this doesn’t have to be only > when stock price =0, as in when time-value of > money > value of the put. > Right. > But (2) above does not mean that shorter maturity > put could be worth more than a long maturity put, > that’s where the confusion is. Sure it does because the price doesn’t have to reach 0 for me to want to exercise the put.
> Sure it does because the price doesn’t have to reach 0 for me to want to exercise the put. So if you have $1000 in a put expiring in 2 days, you want to take out your money and earn interest on it for 2 days. This is the short put. For the same underlying, same terms, but longer maturity, you will have a put worth more not less than the shorter one. The value of the put in this case will be higher (it has 30 more days before expiring). No?
You guys are adding more confusion to this than necessary. For a European Put with a shorter maturity, you can get your money sooner and its more valuable then the money you could get on a longer maturity put IF volatility is low and interest rates are high. It could go either way. Think of it this way… if volatility is low (ie. the $ amount you’ll receive isn’t going to change) and the interest rate is high. Wouldn’t you want to invest that money sooner rather then get the same amount at a later date? If volatility is high and interest is low, the opposite could be true. That’s the reasoning that keeps it clear for me.