Valuation of American

Option
 Difference between European &
American Option
European Option American Option
• It is exercised only on the date of • It is exercised on or before the
maturity. date of maturity.

• It is more riskier than the

American option. • It is less riskier than the European
option.
 American Call Option
A stock price is currently $100. Over each of the next two 6-month
periods it is expected to go up by 10% or down by 10%. The risk-free
interest rate is 8% per annum with continuous compounding. What is
the value of a 1-year American call option with a strike price of $100?
fu/d = max (ST – K,0) S0uu = 121
fuu = $ 21
110
fu
100 S0ud = 99
90 fud = 0
fd
S0dd = 81
fdd = 0
 Solution: 121
•Given
  P fuu = $ 21
So =$ 100, Price =
110
r = 8%, n= 2(each of 6 month)
fu = $ 14.2063 1 -P
99
T = 6 month = 0.5 year fud = $ 0
K = $ 100
• 
,

1 – P =1- 0.7041 = 0.2959

 American Call Option

S0uu = 121

fuu = $ 21
110

fu = $14.2063
100 S0ud = 99

f 90 fud = 0
fd = 0

S0dd = 81

fdd = 0
 American Call Option

110
• 
P fu = $14.2063

100
1-P
𝒇  =$ 𝟗 . 𝟔𝟏𝟎𝟓 90
fd = $ 0
 American Put Option
A stock price is currently $100. Over each of the next two 6-month
periods it is expected to go up by 10% or down by 10%. The risk-free
interest rate is 8% per annum with continuous compounding. What is
the value of a 1-year American Put option with a strike price of $100?
fu/d = max (K – ST ,0) S0uu = 121
fuu = $ 0
110
fu
100 S0ud = 99
90 fud = $ 1
fd
S0dd = 81
fdd = $ 21
 Solution: 121
•Given
  P fuu = $ 0
So =$ 100, Price =
110
r = 8%, n= 2(each of 6 month)
fu = $ 0.2843 1 -P
99
T = 6 month = 0.5 year fud = $ 1
K = $ 100
• 
,

1 – P =1- 0.7041 = 0.2959

 American Put Option

• 
99
P fuu = $ 1

90

fd = $ 10 1 -P
81
fdd = $ 19
 American Put Option

S0uu = 121

fuu = $ 0
110

fu = $ 0.2843
100 S0ud = 99

90 fud = $ 1
f
fd = $ 10
S0dd = 81

fdd = $ 19
 American Put Option

110
• 
P fu = $0.2843

100
1-P

f = $ 3.0353 90
fd = $ 10