Bridge over ocean
9 January 2020 Financial Analysts Journal Volume 76, Issue 1

Option Investor Rationality Revisited: The Role of Exercise Boundary Violations

  1. Robert Battalio
  2. Stephen Figlewski
  3. Robert Neal

The authors dispute the theory that American call options should not be exercised early. By looking at intraday pricing, they find that the best bid price available is often lower than the option’s intrinsic value and early exercise can be rational.

Our empirical results overturn the well-known textbook theory that American options should not be exercised early except in very limited conditions. In the real world, the best bid available in the market is frequently below the option’s intrinsic value (e.g., nearly half of all quotes for in-the- money calls), which we call an “exercise boundary violation” (EBV). In an EBV, early exercise can be the right strategy and the “American” option characteristic has economic value. Some option holders do exercise, some sell at EBV bid prices, and our results suggest that actual exercise behavior is much less irrational than earlier studies concluded.
Read the Complete Article in Financial Analysts Journal Financial Analysts Journal CFA Institute Member Content
CFA Members Earn 2PL
Record PL credit Manage your Professional Learning credits
Publisher Information
Routledge doi.org/10.1080/0015198X.2019.1694362 ISSN/ISBN: 0015-198X

We're using cookies, but you can turn them off in Privacy Settings. Otherwise, you are agreeing to our use of cookies. Learn more in our Privacy Policy.