Hi,
I am struggling with the below:
Normally, options with greater time to expiration are worth more than otherwise identical options that are nearer to expiration. However, in some circumstances, this relationship may not hold for European puts. For example, if the price of the underlying asset goes to zero, the European put with less time to expiration may be worth more because the put holder will receive the exercise price earlier.
Can someone explain me the last sentence please? Why would the put holder receive the price earlier? Thanks
The first point is that European option contracts are only usable at the expiration date where as American option contracts are useable at any time. This is relevant to your question… I will explain.
First, since a put option is the right to sell the underlying… the owner of a put will recieve money if it is ITM (in the money). since a call is the right the buy an underlying… the owner of a call pays money.
so, This is why a European put option can raise in value near expiration… the PV of the cash to be recieved is discounted less if you are entering into the put option closer to expiration. the buyer of that put pays a premium for that.
American puts do not experience this phenomenon since they can be exercised at any time, so the PV of the cash flow recieved is not nailed down to the expiration date.
European calls do not experience this phenomenon because cash is being paid at expiration.
options are awesome!
If the price of the underlying is close to zero, it cannot go down much, but it can go back up.
Therefore, the longer the time to expiration, the more likely it is that the price will go up than down, and the put will lose intrinsic value.
It’s an odd situation: the time value can be negative for deep in-the-money puts.
thanks, it’s clearer to me now