Early Exercise of Cash-Settled American Options and Option Value

Summary

The question challenges the idea that an American option should always be worth more than its intrinsic value, making sale preferable to early exercise. The key correction is that at an optimal exercise point, the option’s value equals its exercise value. The possibility of exercising early is therefore consistent with the option having no additional continuation value at that point.

The replies also distinguish cash settlement from the economic factors that can drive exercise decisions. For an option on a dividend-paying stock, early exercise reasoning can resemble that for physical settlement because equivalent exposure may be obtained by buying shares and collecting the dividend. A further caveat is that even a call on a non-dividend-paying stock may be exercised early under unusual financing or stock-borrow conditions, if borrow costs net of interest on cash outweigh the remaining optionality. The brief discussion gives no valuation framework or quantitative thresholds, so these points are conceptual rather than a complete exercise policy.

Key ideas

• At an optimal early-exercise point, option value equals exercise value.
• The existence of a market sale alternative does not guarantee that the option retains time value.
• Dividend income can affect early exercise decisions even when an option is cash-settled.
• Financing and stock-borrow costs can create exceptions to the usual non-dividend call intuition.

Tags

# Would a cash-settled American Option ever be optimal to early exercised?


# Would a cash-settled American Option ever be optimal to early exercised?












I know that an American call option on a non-dividend paying stock is never optimal to early exercise, but I wonder why would an American option ever even be optimal to early exercise?

My rationale is as below:

Given an option with an intrinsic value of $S-K$, the decision is one choosing between early exercising and selling the option in the market. The value of the option should always be greater than the intrinsic value, or else, one can always buy the option and exercise it to make an immediate profit. It would always be better to sell the option instead of exercising it.

Appreciate if anyone could point out the mistakes in my argument.

## Answer by Mark Joshi (score 3)

https://quant.stackexchange.com/a/32823

if it's at a point of optimal exercise its value is the exercise value so your statement that the value is more than the intrinsic is wrong.

## Answer by Nivel Egres (score 0)

https://quant.stackexchange.com/a/32832

If the underlying is a dividend paying stock, your early-ex decision should be identical to physical, as you can buy the stock in the open market and collect the dividend. Also, your statement that an American call on zero div stock should never be early exercised is wrong. If the stock borrow net of interest on cash is higher then your residual optionality, that would be one exception.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.