| 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 ...