Suppose that a non-dividend paying stock is trading at $80 and the risk-free rat

Question

Suppose that a non-dividend paying stock is trading at $80 and the risk-free rate is 4.0% (continuous compounding). Consider two American call options with two-months to expiration – one with a strike price of $100 and another with a strike price of $60. The value of the $100 European call option is $0.50, and the value of the $60 European call option is $20.75. There also exist corresponding American put options.

a. Should the $60 American call option be exercised today? What about the $100 American call option?
b. Should the $60 American put option be exercised today? What about the $100 American put option?

Explanation / Answer

Solution-a

No, for both options. American (call option) non dividend paying stock never be exercised early. On the basis of the $100 American call option is out of money.

Note-

Do not add any gains but you give  up the option value and pay the strike price early.

Solution-b

The $100 exercised early and $60 is out of the money (American put option).

So, Now the value of the European Put option as follows....

PE =C-S+PV(K)

PE =  $19.83

If the early exercised is ignored than the  $19.83 will consider and if we exercised today than the  intrinsic value will be consider $20.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.