Option Volatility & Pricing Workbook: Practicing Advanced Trading Strategies and Techniques

| CHAPTER 13 |

Early Exercise of American Options

All options have a lower arbitrage boundary. If the option is trading at a price below this lower arbitrage boundary, and there are no transaction costs, then a trader can be certain of a profit by buying the option and hedging the option position against the underlying contract.

The lower arbitrage boundary for European options:

call: maximum [forward price – exercise price) / (1 + interest rate × time),0]

put: maximum [exercise price – forward price) / (1 + interest rate × time),0]

The lower arbitrage boundary for American options:

maximum [European lower arbitrage boundary, intrinsic value]

In questions 1 and 2, what are the lower arbitrage boundaries for the given options if they are both ...