Question

In: Finance

It is well-known that an American call option written on non-dividend paying stock shouldn’t be exercised...

It is well-known that an American call option written on non-dividend paying stock shouldn’t be exercised early. Please explain why an American futures call might ever be worth exercising early, even if the underlying stock of the futures doesn’t pay any dividend. (Hint: what is the risk neutral probability for pricing future option, and what is the risk neutral probability for pricing a stock option where the stock is dividend paying?)

Solutions

Expert Solution

American futures call options might be worth exercising early because they will be leading to receipt of money and it will also mean that investor are not going to lose on time value of month due to exercising late and if the investor is keeping his exposure into the American call option then he is still exposed to the risk of downside, so if he is making a profit and he is expecting that their prices are not going to go higher and options value are going to lose because of depreciation due to the time value of option factor,so he will be exercising it early in order to protect himself from risk and he will also exercise early because he will be wanting not to lose on the time value of option front and protect himself from any depreciation of time value of money.

Hence, he should be exercising the American call option early because he thinks that there are no possibilities of shares going up and there are also implications of time value of money factor and he is a risk averse investor so he won't be able to keep himself exposed to the risk if he is realising the profit and hence he will book his profit and exercises call option early.


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