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An Explanation of Seemingly Anomalous Time Premium Behavior for American Put Options

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Author Info
Rovert Geske (Anderson School of Management)
Kuldeep Shastri (University of Pittsburgh)

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Abstract

ABSTRACT It is thought that American options always gain value as the time to the option's expiration date increases. Merton (1973) proved this result using simple arbitrage arguments for options on non-dividend paying stocks. However, market prices reveal that (i) an American put can increase in value as calendar time passes diminishing the options time to expiration and (ii) two puts which differ only in expiration cycle can "sell" for the same price (i.e. a zero differential time premium). This paper demonstrates that dividend payments can cause this seemingly anomalous time premium behavior for American put options.

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File URL: http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1208&context=anderson/fin
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Publisher Info
Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number 1208.

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Date of creation: 01 Nov 1986
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Handle: RePEc:cdl:anderf:1208

Note: oai:cdlib1:anderson/fin-1208
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  1. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring. [Downloadable!] (restricted)
  2. Geske, Robert & Johnson, Herb E, 1984. " The American Put Option Valued Analytically," Journal of Finance, American Finance Association, vol. 39(5), pages 1511-24, December. [Downloadable!] (restricted)
  3. Whaley, Robert E., 1981. "On the valuation of American call options on stocks with known dividends," Journal of Financial Economics, Elsevier, vol. 9(2), pages 207-211, June. [Downloadable!] (restricted)
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This page was last updated on 2009-11-19.

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