Which of the following is the lowest possible value of an American put on a stock with no dividends? A)X(1 + r)^-T B)X C)Max[0,X(1 + r)^-T - S₀] D)Max(0,X - S₀) E)none of the above

Question

Quizplus · Accepted Answer

The lowest possible value of an American put option is when the option is deep in the money and the stock price is close to zero. When the stock price is close to zero, the second term in all the equations approaches zero, making them all equal to X. Therefore, the only relevant term is the third term, which is the cost of early exercising the option. The cost of early exercising is the strike price minus the present value of the expected payoff at expiration, discounted at the risk-free rate. The expected payoff is zero when the stock price is close to zero because the put option guarantees a minimum value of X. Therefore, the lowest possible value of an American put option is Max(0,X - S₀).

Which of the Following Is the Lowest Possible Value of an American