The biggest difference between American and European options is that American options can be exercised before maturity. How do you price American options? In which situation makes it better to exercise American options early? In this case, the shares of IBM are trading at $83. Assuming the annual volatility of IBM is 30%, annualized risk free rate is 5%, and strike price of its American options (call/put) is $70, I priced the call option by a two step binomial tree approach with 4 months to maturity. In 2 months, the stock pays a dividend of $5. In addition, I evaluated the put option by the replicating portfolio approach.
Your browser does not support viewing this document. Click here to download the document.