Question

Stock options prices are affected by a number of factors and arbitrage arguments are used to find the fair values of these options.

1. (1) Explain the three reasons why the early exercise of an American call option on a non-dividend paying stock is never optimal.

   (approx. 100 words)

Answer 1

Above all else, this just applies to a call option. The more broad detailing is that in the event that you have an option to trade A for B, and A conveys a higher payout than B, you would prefer not to exercise early. That applies to the instance of a call option to trade money (which pays the interest rate) for a non-dividend paying stock (that pays nothing); however not to the situation of a place option in which case you're trading a zero payout stock for positive payout money.

From this detailing you can likewise observe that it probably won't have any significant bearing if there are zero or negative interest rates, or non-money motivations to hold the stock, or expenses of holding money or leaving the position open. In addition, it's a hypothetical outcome that holds in flawless markets, there might be charge or managerial or administrative motivations to exercise early.

Assume you claim a call option to get one offer of XYZ stock in a month for $100. XYZ will pay no dividend throughout the month. $100 will acquire $0.25 of interest throughout the month.

Assume you are 100% certain you will exercise in one month. Despite everything it bodes well to hold up until the month's end to exercise, since you'll procure an additional $0.25 keeping the $100 up to that point. Also, in case you don't know you're going to exercise, that is, on the off chance that you think XYZ stock may be underneath $100 in a month's time, at that point you absolutely would prefer not to exercise now, since then you'll lose cash if XYZ falls beneath $100.

Be that as it may, assume XYZ is selling today for $200. You could exercise, sell the stock for $200, and contribute the $200 to acquire $0.50 throughout the month. In any case, you would be in an ideal situation shorting XYZ and holding the option. Presently you make $0.75 in interest, on $200 structure the short deal continues and $100 of exercise cost. Furthermore, if XYZ is selling for under $100 in a month, you can cover the short by obtaining in the market instead of practicing the option.