Skip to content

FRM Part I · FRM Exam Part I · Properties of Options

A stock pays no dividends and trades at $50. An American put has strike $60 and the stock is at $50 with a risk-free rate of 5%. The put is deeply in the money. Which factor most directly makes early exercise of the American put potentially optimal?

Early exercise of an American put can be optimal because receiving the strike now allows interest to be earned on it. When the put is deep in the money, the limited further downside (stock cannot fall below zero) means the interest gained outweighs the remaining option insurance value.

  1. AThe put's immediate payoff of K - S can be invested at the risk-free rate, and the benefit of earlier receipt of the strike outweighs the remaining insurance valueCorrect
  2. BPositive stock drift makes waiting more attractive
  3. CThe put's value is capped at the stock price
  4. DDividends are expected to be paid soon

Explanation

Exercising a put delivers the strike K now rather than later, so interest can be earned on the proceeds. When the put is deep in the money, the stock cannot fall much further (floor at zero), so the remaining insurance value is small relative to the interest gained. The dividend answer contradicts the data, as the stock pays none.

Did you get it right without looking?

One question tells you little. A timed set on Properties of Options shows your real accuracy, how long you take and where you lose marks.

Practise Properties of OptionsFree diagnostic mock

More Properties of Options questions