Question

Explain when it would be appropriate to exercise calls early. Explain when it would be appropriate to exercise puts early. Given that they are in the money, give an example of when exercising early would be inappropriate. Explain your answer.

Explain the effect of interest rates and volatility on both calls and puts. Calculate T if today is March 10 and the option ends on September 5.

Answer 1

It will be better to exercise the call early when the call is providing with higher profits and it will also mean that there is an expectation that the share is not going to go up more and hence one should be trying to exercise the call as early as possible in order to save from reduction in the value of call option due to decay of time value of option.

It will also better to exercise the put option early when share has fallen below strike price and the higher games are realisable and it is also expected that shares are not going to fall more in the coming days till the maturity period so investors should try to protect upon the depreciation of the time value of put option

Exercising early will be inappropriate as their expectations are that these call options are going to benefit more and they are going to rise more than the decay of the time value of option so it would not be wise to exercise the options in such scenarios.

Volatility will always have positive relationship between the valuation of call option and put option because when there will be a higher volatility the value of options will be going up due to increased probability of availability of their strike price.

For an example, if the strike price of call option is 75 and the underlying securities has risen till 90 and the profits on the premium paid is 10, what if we are holding this option for the longer period it will mean that the price will revolve around 90 and the call premium is going to go down in single digits due to depreciation in time value of option. Hence it will be better to exercise early.