2

While studying for the CFA, I ran into the following statement in my study materials: "American style calls are only more valuable than European style calls IF the underlying asset pays cash flows, such as dividends or interest".

Lets imagine a stock call option. Even if the underlying is a no-dividend-paying stock, its price is still going to fluctuate, so that there is a higher chance that the American call could be exercised above the strike price than the european, since there is simply a higher chance that S is going to be higher than X on any given day during the period until expiration than ONLY on the day of expiration.

Could someone help me understand this? I realize there is a simmilar question in the forum, but it is not identical. Thank you.

Improve this question
1
  • 1
    Did you read the material completely ? I have read it and it is clearly explained in detail in one of the chapters. Read it. – DumbCoder Apr 12 '17 at 9:11
3

Really all you need to know is that American style can be exercised at any point, European options cannot be exercised early. Read on if you want more detail.

The American style Call is worth more because it can be exercised at any point. And when the company pays a dividend, and your option is in the money, if the extrinsic value is worth less than the dividend you can be exercised early. This is not the case for a European call. You cannot be exercised until expiration. I trade a lot of options, you wont be exercised early unless the dividend scenario I mentioned happens. Or unless the extrinsic value is nothing, but even then, unless the investor really wants that position, he is more likely to just sell the call for an equivalent gain on 100 shares of stock.

Improve this answer
4
  • So the dividend isn't paid to whoever held the stock at announcement? The announcement sets some future date? Far enough out to settle the option exercise in time to get the dividend? What's a typical elapsed time between announcement and payout? – feuGene Apr 13 '17 at 1:20
  • @feuGene, Dividends are generally announced including an ex-dividend date and a dividend payment date. To answer your question; no, the dividend isn't paid to whomever held the stock at the announcement because the announcement will include a future date on which shareholders of record are paid the dividend. – quid Apr 13 '17 at 2:09
  • "The American style Call is worth more because it can be exercised at any point. And when the company pays a dividend, and your option is in the money, if the extrinsic value is worth less than the dividend you can be exercised early." This statement is not true. There is no profitable arbitrage available for an ITM call in such circumstances. It is true for the ITM put NOT the ITM call. Run the numbers and this will be apparent. – Bob Baerker Dec 11 '19 at 23:05
  • Writing an ITM call option (american style) for the nearest month of a dividend-paying-stock on the dividend record date is like a free-lotery ticket. If you don't get assigned, the option will decrease with approximately the dividend cash amount. That is nice if you wrote the option, not so nice if you're the one that forgot to exercise this long call position. – Paul Verschoor Apr 28 at 19:12

Not the answer you're looking for? Browse other questions tagged or ask your own question.