Question

Consider an American put option on a non-dividend paying stock. The option will expire on date T. On date t(< T), the option payoff from the immediate exercise is always lower than the value that results from not exercising and holding the contract.

(a) True

(b) False

Answer 1

True.

It is better to hold the contract.

In case of an American put option,early exercise of the option is not optimal,especially when it is a non dividend paying stock.

The option has time value.If we are holding the contract till expiration then there is a possibility of getting more interest.That means ,the option holder is able to earn interest on the strike price for a longer period of time.

Holding the contract gives maximum value.The option might increase the value when it is held to expiry.So exercising would lose the opportunity to get further gain.