Hi all, Need some help understanding LOS 71(n) that talks about early exercise of American Call Options. The LOS implies that there is no reason for early exercise of American Call Options on non-dividend paying stocks. However, if the strike price is 30, & today stock price is 32… and at expiration the stock fell to 31, wouldn’t it have been more profitable if the option were exercised before the expiration date?
but how would you know beforehand that the stock would fall to 31
And how would have exercising the option earlier helped you? In the end the numbers should be same… exercising the option earlier will give you ownership of the stock @ 30/share. Assuming you sell the stock at 32, you’d pocket $2/share. Closing your option position would pocket you the same amount. In fact, exercising the option may be costlier due to additional transaction costs (and the money you’d pay for stocks). If your intention is to actually own the stock into perpetuity, then it makes sense to exercise the option. If you intend to pocket the profit, it is better to close the option position.
Well, the rationale is that American options have positive time value, in addition to intrinsic value. If you exercise early, you receive only the intrinsic value, thus squandering the time value.
@zyunjuan: I do not know this beforehand, what I was wondering was if the stock price fell to the value I mentioned, what would be the rationale behind not exercising it early. I think ohai’s reply makes sense. I also looked up this thread after getting home from work: http://www.wilmott.com/messageview.cfm?catid=8&threadid=67252