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ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions

Which of the following statements about option values is correct for options on a share that pays no dividends during the option's life?

An American call on a non-dividend share is worth the same as the equivalent European call. Early exercise would sacrifice time value and the interest benefit of delaying payment of the exercise price, so it is never optimal. The other statements misstate how puts, time to expiry and interest rates affect option values.

  1. AAn American call is worth the same as an otherwise identical European call, because early exercise is never optimalCorrect
  2. BAn American put is never worth more than an otherwise identical European put
  3. CThe value of a European call falls as the time to expiry lengthens
  4. DA rise in the risk-free rate increases the value of a European put

Explanation

Exercising a call early forfeits its time value and the interest earned on the exercise price, so it is never optimal without dividends. The American call therefore equals the European call. An American put can be worth more because early exercise may be optimal. A longer time to expiry generally raises a call's value, and a higher risk-free rate lowers a put's value.

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