Actuarial Outpost Question about American Call option with one discrete divident
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#1
08-01-2012, 12:03 AM
 dennisli Member SOA Join Date: Apr 2011 Studying for MLC College: Univ of Michigan Favorite beer: IPA! Posts: 119
Question about American Call option with one discrete divident

So I am a little confused about when the option should be exercised early:

First of all, if D-P(1-e^r(T-t))>0, then there is more dividend than the potential interest earned if not exercise, so it's optimal to exercise early..

Then, the other one is to compare this (since it's the strike price of the callonput otion with the price of the Put)

If D-P(1-e^r(T-t))>P then its optimal to exercise it early..

Can anyone explain a little bit more about the difference of these 2 criteria?
#2
08-01-2012, 12:29 AM
 Epsilon5 CAS SOA Join Date: Jun 2012 Posts: 19

I think you meant D-K and not D-P, as K is the strike price.

I'm reading the manual as saying if D-K(1-e^r(T-t))<0, then it is certainly not rational to exercise. This does not imply that if D-K(1-e^r(T-t))>0 it is certainly rational to exercise. Determining if it is rational to exercise requires also looking at the implicit put, the second condition you stated.
#3
08-01-2012, 10:55 AM
 dennisli Member SOA Join Date: Apr 2011 Studying for MLC College: Univ of Michigan Favorite beer: IPA! Posts: 119

yea, that's a typo, thanks for pointing it out, i meant to type K.. and your explaination makes sense as well, i appreciate.

 Tags call on put asm