Euro Vs Amer Call Bond exercise, stocks, paying, about

mdfb79

The possibility of early exercise is not valuable for a call options on non-dividend paying stocks. Can anyone elaborate, also What about put options?

Analyze_This

CFAI Vol 6 page 177. They relate this tough concept to renewing a subscription before the original one runs out. Not only to you lose the interest on the money, you lose the choice.

mp3bu

I think its pretty stupid, surely having the option to excercise early would be valuable with or without a dividend yield, even for pure liquidity reasons.

But I think the idea was that you could call it before the stock goes ex-dividend, and the price falls

wilslm

The idea is that you could exercise early with the American Option and reinvest the dollars. Because there is no cash flow you cannot do this.

spreads

Thanks Chuck.

Chuckrox8 Wrote:
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> The idea is that you could exercise early with the
> American Option and reinvest the dollars. Because
> there is no cash flow you cannot do this.

WarrenB1

pedpenny Wrote:
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> I think its pretty stupid, surely having the
> option to excercise early would be valuable with
> or without a dividend yield, even for pure
> liquidity reasons.


It's not stupid.

Think about what actually happens when you exercise an option on a stock prior to expiration. You exercise the call and you get the underlying. The stock you now own is still exposed to price fluctuations between now and expiration date and you just screwed yourself by deciding whether or not you want the stock earlier than when had to decide. Of course you can exercise and just sell the stock immediately but why not just sell the option or close out of the option? You're better off selling the option when you've made money on it vs exercising it way ahead of expiration.

Since you're better off just selling the option it ends up being the exact same thing as holding a European option.

The reason why this may not work out in real life is because of commissions, transaction fees and matching up order sizes; you won't be able to close out of a losing 10,000 contract position the day before expiration at a justifiable cost when you're paying commissions of $1 per contract. It has nothing to do with whether the market adjusts its prices as stated above.



Edited 2 time(s). Last edit at Wednesday, May 11, 2011 at 03:21PM by verse214.

ryanlb

. Im arguing over the value of excercising early with regard the dividend yield, lets say its in the money (lets face it you are not going to excercise if its out of the money just for a dividend, unless the dividend is very big and offsets your loss) and you excercise to get the upcoming dividend which you can re-invest as chuck said, so you own the stock and you get the dividend, now do they hold onto the stock after the get the div or do they sell the stock aswell and reinvest that?

Now lets say its a non-dividend paying stock, but its in the money, and you excercise and sell the stock after, and reinvest that, is that not the same objective as reinvesting the dividend.

My other point was lets say I had a sudden liquidity shortage, and I needed cash real bad, and I owned 100 options on a stock that was in the money, being american I excercise the option... yes as im writing this I get your point on just selling the option, for the cash, so it wont matter if it is euro or american

Pegasus2008

ohai Wrote:
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> If you hold the option, you don't receive the
> dividend. So tomorrow, all you will have is the
> option to buy the $95 stock for $0. So, your value
> is $95. Obviously, first scenario is superior in
> value.

In your senario, the options exchange would adjust the price of the option to include a cash component, something that commonly happens... check out some option quotes and you'll see sometimes odd option series published for this and other similar reasons. You gain nothing by exercising early, except for some possible liquidity and transaction cost purposes.

RepoToronto

Dreary Wrote:
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> In the real world, this is complete nonesense.
> Markets adjust the price of options whose
> underlying has a dividend coming up. You gain
> nothing by exercising and thinking you get the
> dividend. No such thing as a free lunch, CFAI.

That just means you are indifferent to early exercise or selling the option. There clearly exist options that need to be exercised early. For example, suppose you have an option on a $5 stock with a $5 dividend with a strike of $3. Whoever owns that option needs to exercise and get the dividend.

comp_sci_kid

The original question asks why there is no benefit to early exercise on stocks with no dividends.

its vwry simple: the value of my call option will always be greater than just the intrinsic value component because of time value (which diminishes at an increasing rate as we approach expiration).

If we exercise, we just capturing the intrinsic value and we lose out on the time value component.

example: i own a call option with a strike at $10 and the underlying is $12. The value of my option is at LEAST $2 where if i exercise the value is EXACTLY $2 (aside from costs). Further, Ive tied up my capital by exercising.

As far as the put goes, the same logic applies only it also applies to stocks that pay dividends as well.