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Options exercise - excel

Options exercise - excel

by João Pedro Martins Balula -
Number of replies: 1

Dear Professor,

I am having some trouble understanding the American put option exercise on sheet Options (iii) of the "Examples for Class Excel" available on Moodle, specifically the part that refers to "part of Dividends around slide 41." As I am reviewing it, I don’t understand why the decision in cell M93 was to not exercise the American put option. In my understanding, it would make sense to exercise the option after the dividend is paid, since the strike price ($25) - S_d_post ($16.25) = $8.75, which is higher than p_d_Euro ($7.53).

I would appreciate any clarification on this.

Thank you very much!


In reply to João Pedro Martins Balula

Re: Options exercise - excel

by Martijn Boons -

Hi Joao, the decision is whether to exercise BEFORE the dividend is paid (in which case you get 25-21.25=3.75) or keep the option alive (in which case you have an option with 7.53). In these setups we always need to make an assumption about when you can exercise (just before or after the dividend is paid). The former matches better with our replication strategy, because if you buy some stock to replicate at time 0, you will get some dividends. (And if you sell short some stock to replicate, you need to pay the dividend.)

M