CFA Practice Question
When comparing two European puts, it can be said that ______
A. the put with the longer expiration period has a higher value.
B. a longer expiration period may not be beneficial for such a put option.
C. the put with the lower exercise price would be more valuable.
Explanation: While a longer expiration period is beneficial to a European call, it is not so for a European put. If the stock drops to zero before the put can be exercised, the holder has to wait until expiration to exercise the option. This detracts from the value of such a put option.
User Contributed Comments 8
| User | Comment |
|---|---|
| eddeb | But this is not true for European call? |
| mtcfa | I don't believe so because your theoretical gain is unlimited. |
| staudinger | the holder of the long put has always to wait until expiration to exercise, that's the nature of a european option (no early exercise) |
| trikee01 | yes, but what if you wanted to exercise the call at a certain point because the stock had a nice run and you couldn't? A long expiration here would be a detriment to the call. |
| fmuntz | the max value of a put is its strike minus the value underlying - so effectively the underlying value being ~zero - so waiting to exercise this max value you loose the risk-free return - as others said above there's isn't such an absolute max value under a call... |
| Kashi2010 | Find me a put with a longer time to maturity in the market selling for less than an identical put with shorter maturity then?!?! They dont exist. Nice theory, but since the probability of prices reaching zero (and not staying there) is virtually nil, this is a meaningless theoretical idea. Especially since if a price reaches zero a stock will be delisted and likely create a cash settlement obligation for the writer at that time, irrespective of final maturity. |
| Kunga | Kashi2010.. that's incorrect, such puts do exist. Look at deep in the money puts. I think a simpler way to think about this concept is that if your put becomes deep in the money and it's a longer time-to-maturity, you have to wait longer before you can start collecting interest on it, hence its value will be less than that of a shorter time-to-maturity put. |
| Downgrade | Stupid Question. If you are long a put or a call (european) you can immunize further g/l by going short or long the stock or a combination of puts and calls. |