Subject 12. American Option Pricing

American options can be exercised early. Their prices must always be no less than those of otherwise equivalent European options.

American call options:

C0 = Max[0, S0-X/(1+r)T]

American call options, however, are never exercised early unless there is a cash flow on the underlying. The extra value of an American option, if any, comes from the fact that it can be exercised immediately.

American put options:

P0 = max[0, X - S0]

American put options nearly always have a possibility of early exercise, so they ordinarily sell for more than their European counterparts.

User Contributed Comments 5

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6162: two aspects of american options:1)possibility of early exercise and 2)have a value higher than those of the european options
tschorsch: American options have a value no less than the same european option, this is NOT the same as "have a value higher".
They often would be priced at exactly the same value. also, the possibility of early exercise does not necessarily mean that there is an advantage in doing so.
Almost always (except for calls when there is a cash flow - coupon or dividend), to realize the maximum profit, it is best to just sell the option, as it has some time value remaining.
dexterity: right
nmech1984: this is the eeeeeend of cfa studying!
nmech1984: lol, I made the comment at the end of the next Reading and AN moved it here! Relax guys just one Reading.