The value Max[0, K(1+r)-T – S0] was shown to be the lowest possible value of a...
The value Max[0, K(1+r)-T – S0] was shown to be the lowest possible value of a European put. Why is this value irrelevant for an American put?
Homework Answers
There is a basic difference between American style Put and European Style Put. An American Put option can be exercised at any time during its life and on the other hand European Put can be exercised at expiration.
Thus, In case European put, Exercise price discounted to present value to calculate the lowest possible value. But, In case American Put, it is not discounted because put holder can exercise his right next day or in a week. Generally, American Puts are exercised before the expiration as soon as investor is able to get some profit and invest the proceed to risk free investment.
Thus, Lowest possible value of American Put:
where,
K = Put exercise price
S0 = Current price of stock.
Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.
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