9 month American option (underlying) is known to pay dividend of
USD 1 and USD 0.75 at the end of the
3rd and the 07th month respectively. The
strike price considered is
USD 45. The
Risk Free Rate is continuously compounded and is fixed at
6% over the tenure. The
stock is currently trading at
put options are trading at
USD 7.5 and the
call options at
USD 4.0. What would be the optimum time to exercise the call and put option based on the information given above?
The answers for the above questions are :-
a) The American call option should be bought and exercised at the second dividend.
b) The American Put option should be bought, but should not be exercised before the first dividend payoff.
How to arrive at this solution?