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Directly measuring early exercise premiums using American and European S&P 500 index options

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  • Michael Dueker
  • Thomas W. Miller, Jr.

Abstract

The Chicago Board Options Exchange concurrently listed European-style and American-style options on the Standard and Poor's 500 Index from April 2, 1986 through June 20, 1986. This unique time period allows for a direct measurement of the early-exercise premium in American-style index options. In this study, using ask quotes, we find average early exercise premiums ranging from 5.04% to 5.90% for calls, and from 7.97% to 10.86% for puts. Additionally, we are able to depict a potentially useful functional form of the early exercise premium. As in previous studies, we find some instances of negative early exercise premiums. However, a trading simulation shows that traders must be able to trade within the bid-ask spread to profit from these apparent arbitrage opportunities.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2002-016.

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Date of creation: 2002
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Handle: RePEc:fip:fedlwp:2002-016

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Keywords: Options (Finance) ; Stock market;

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  1. Blomeyer, Edward C. & Johnson, Herb, 1988. "An Empirical Examination of the Pricing of American Put Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(01), pages 13-22, March.
  2. Amihud, Yakov & Mendelson, Haim, 1980. "Dealership market : Market-making with inventory," Journal of Financial Economics, Elsevier, Elsevier, vol. 8(1), pages 31-53, March.
  3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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