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

Holding all else equal, which change makes early exercise of an American put on a non-dividend-paying stock more attractive?

A higher risk-free interest rate makes early exercise of the American put more attractive, because the strike cash received earlier can earn more interest. Higher volatility, a higher stock price, or lower rates all favour keeping the option alive.

  1. AAn increase in the stock's volatility
  2. BA decrease in the risk-free interest rate
  3. CAn increase in the stock price
  4. DAn increase in the risk-free interest rateCorrect

Explanation

Exercising a put early delivers the strike sooner, and that cash earns interest. A higher risk-free rate raises this benefit, so early exercise becomes more attractive. Higher volatility increases the option's time value, which favours waiting. A lower rate reduces the interest gain. A higher stock price moves the put away from the money, making early exercise less attractive.

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