Finance 4366 will not meet in person tomorrow, Tuesday, March 19, due to ongoing health-related issues in my family. Therefore, tomorrow’s “American Options, Part 2” lecture will be delivered asynchronously. As in last week’s asynchronous lectures, class participation credit will be awarded to students who write and upload a lecture synopsis to Canvas.
In my March 14th lecture, I showed how Cox-Ross-Rubinstein (CRR) binomial option pricing model prices and probabilities converge toward Black-Scholes-Merton (BSM) continuous-time model prices and probabilities. Additionally, I began the first of two discussions on American option pricing. Unlike European options, which can only be exercised on their expiration date, American options can be exercised anytime between the contract’s start and expiration. We focused on American options for stocks that don’t pay dividends and observed that while it might be optimal to exercise an in-the-money put option early, it will never be optimal to exercise an American call option written against a non-dividend-paying stock.
In American Options, Part 2, we’ll explore scenarios where the early exercise of an American call option may be optimal when the underlying asset does pay dividends. It draws heavily from the Effects of Dividends on the Pricing of European and American Options teaching note.