Compared to a European option the value of an otherwise iden

Compared to a European option, the value of an otherwise identical American option is...(please explain)

a. sometimes less, and never greater.

b. always equal to the value of the European option.

c. sometimes greater, and never less.

d. always greater.

e. always less.

It is never rational to exercise an American ____ option on a ___________ stock prior to its expiration date.(please explain)

a. call ... dividend-paying

b. put ... non-dividend-paying

c. call ... non-dividend-paying

d. put ... dividend-paying

Solution

Answer 1) As an American option can be exercised at any point of time, so it worth more than the European options which can only be exercised at expiration time. So, Compared to a European option, the value of an otherwise identical American option is at least equal to or greater than the value of identical European option. Determining the above explanation, Part C is the suitable answer.

Answer 2) It is never rational to exercise an American call option on a non-dividend paying stock prior to its expiration date as this will lead to loss of money by exercising early instead of selling it in the market, whereas it would be optimal to exercise prior to expiration date if there are dividends. Determining the above explanation, Part C is the correct answer.