Early exercise

Exercising an American option before expiry. It can pay for a deep in-the-money put, to earn interest on the strike sooner, but a call on a non-dividend-paying share should never be exercised early.

Where you will meet it

Early exercise appears in 2 learning outcomes on the CFA syllabus. A few of them:

• Use a two-period binomial model to work out no-arbitrage values for American and European options
  CFA Level II · Derivatives and Risk Management

  “Early exercise can pay for a deep in-the-money American put, because receiving the strike early earns interest; an American call on a non-dividend-paying share is never exercised early and equals the European call.”

• Name the assumptions behind the Black–Scholes–Merton model for valuing options
  CFA Level II · Derivatives and Risk Management

  “The model does still price an American call on a non-dividend-paying share, since early exercise is never optimal for it while interest rates are not negative.”

See also

American option

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with E · Glossary