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IAI Actuarial Core Principles · Economic Modelling · Principles of option pricing

A share pays a known large dividend just before the expiry of an American call. Compared with a similar non-dividend-paying share, which statement is correct?

With a large dividend due, an American call may be exercised early, just before the ex-dividend date. The holder then receives the dividend, whereas waiting means facing the price drop. This can outweigh the interest saved by deferring payment of the strike.

  1. AEarly exercise just before the ex-dividend date may become optimal, because the share price falls by about the dividend afterwardsCorrect
  2. BEarly exercise is never optimal, whatever the dividend
  3. CEarly exercise is optimal immediately after the ex-dividend date
  4. DEarly exercise is optimal only for put options
  5. The dividend raises the call value, so early exercise is less attractive

Explanation

The share price drops on the ex-dividend date, lowering the call's value. A call holder can capture the dividend only by owning the share beforehand, so exercising just before ex-dividend can be optimal if the dividend outweighs the lost interest and time value.

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