Explanation:
The payoff from exercising the option is the exercise price minus the current stock price: $40 − $36 = $4. The discounted value of the expected future payoff is:
It is optimal to exercise the option early because it is worth more exercised ($4.00) than if not exercised ($2.38).
(Book 4, Module 60.1, LO 60.a)
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Question 85
A 1-year American put option with an exercise price of $40 will be worth $10.00 at maturity with a probability of 0.25 and $0.00 with a probability of 0.75. The current stock price is $36, and the discount rate is 5%. The optimal strategy is to:
A
exercise the option because the payoff from exercise exceeds the present value of the expected future payoff.
B
not exercise the option because the payoff from exercise is less than the discounted present value of the future payoff.
C
exercise the option because it is currently at-the-money.
D
not exercise the option because it is out-of-the-money.
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