QBank Question 95621 (American Options) positive, sometimes, following, statements

badonkus

Which of the following statements about the early exercise of an option is least accurate? For an American:
A) call option, on an asset with no cash flows, early exercise can be profitable if the option is far in the money.
B) put option on an asset with no cash flows, early exercise is sometimes optimal.
C) call option on an asset with positive cash flows, early exercise is sometimes profitable.
Your answer: C was incorrect. The correct answer was A) call option, on an asset with no cash flows, early exercise can be profitable if the option is far in the money.
Early exercise of an American call option on an asset with no cash flows is never profitable, they are worth more ‘alive than dead’.
*How is this A, or any of the answers? Early exercise of any American option is profitable if it’s in the money minus the cost of the option.

KungFuPanda

Your are not limited to either exercising the option or waiting. You are allowed to sell it.
I think the question is alluding to that the time value of the option, will increase it above its intrinsic value. Thus, selling it would be more optimal than exercising.

malbec

Nope…
Options have one sided payoffs. Even if your American call is deep in the money, you would rather not exercise immidiately.
Reason:
If there is time remaining till expiration, there is a chance of the stock prices rising or falling. Therefore, the option can go deeper in the money, or out of the money. Given this scenario, your minimum payoff is limited to zero, while your possible upside is unlimited. An investor would gamble on the upside…