A non-dividend-paying option on a stock is most likely to be exercised early if the option is a(n): A)
call option. B) European option. C) put option. The correct answer is C. The explanation is After exercising a deep in-the-money put early, the sale proceeds can be invested at the risk-free rate, and in this way the investor may earn interest worth more than the time value of the put. Non-dividend-paying call options on stock will never be exercised early because the minimum price of the option always exceeds its exercise value. Can anyone please explain this concept? Thanks in advance.
Deep in-the-money puts can have negative time value.
Thanks, but can you please elaborate. What about call options?
Call options always have positive time value, because the price of the underlying can increase without bound.
Deep in-the-money put options can have negative time value because the price of the underlying cannot go below zero; eventually, it’s more likely that the price of the underlying will increase (decreasing the value of the put option), than that the price of the underlying will decrease.
Understood, so the holder of the put option will not wait until the value of the underlying asset increases especially for a non-dividend paying stock. The holder will exercise it early. Thank you very much.
My pleasure.
How should this scenario change if the stock is paying dividend?
You might exercise an American call early in that case, to receive the dividend.
1 Like