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

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  • Geske, Rovert
  • Shastri, Kuldeep

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.

Suggested Citation

  • Geske, Rovert & Shastri, Kuldeep, 1986. "An Explanation of Seemingly Anomalous Time Premium Behavior for American Put Options," University of California at Los Angeles, Anderson Graduate School of Management qt8t9863d8, Anderson Graduate School of Management, UCLA.
    • Handle: RePEc:cdl:anderf:qt8t9863d8
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