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

Which statement about the time value and early exercise of options on a non-dividend-paying share is correct?

An American call on a non-dividend share should never be exercised early, because doing so forgoes time value and interest on the strike. So its value equals that of the equivalent European call.

  1. AAn American call should never be exercised early, so it has the same value as the equivalent European callCorrect
  2. BA European put always increases in value as time to expiry increases
  3. CAn American put is never worth more than the equivalent European put
  4. DA European call decreases in value as time to expiry increases
  5. Longer time to expiry reduces the value of an American option

Explanation

Without dividends, an early-exercised call gives up time value and the interest on the strike, so it is never optimal to exercise early; American and European calls are equal in value. A European put may fall in value with longer expiry. An American put can be worth more than a European put because early exercise can be optimal.

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