Question

Question 14. In which situation should you exercise an American call or an American put early, assuming no dividends? Provide your reasoning.

Answer 1

There are mainly two situations in which an american call or put option can be exercised early, where the stock pays no dividend.

Firstly, it is simply the need for fund or cash. It is over the counter transaction. The situation may not be appropriate,but it is the need that matters. This case is not affected by the price or profit, but is just the sentiments and the need.

Second reason is somewhat related to the stock price. The pricing of the option includes two elements - intrinsic value and time value. Intrinsic value is the worth of that stock. If the price that the stock arrived at its price on maturity, is more or less near to the current market price of the stock, it is better to exercise the option. Holding the option effects the time value of the option. Time value of the option means the decrease in the value of the money in the future compared to the present value of money. Holding the option when the current price equals the intrinsic value is not worth it. It is often advicable to exercise an option when the current price of the option reaches its intrinsic value. It is the major situation in which an option is exercised early.