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Taxation and the Early Exercise of Call Options

Karen Alpert

Journal of Business Finance & Accounting, 2010, vol. 37, issue 5-6, 715-736

Abstract: Prior studies of call option early exercise either ignore personal taxes or simplify the impact of taxation. When making an early exercise decision, the option holder should compare the after-tax cash flows from exercise with the after-tax cash flows from selling the option. Due to the differential taxation of option and share transactions, it is possible for exercise to be wealth-maximizing after tax even when it would not be the rational decision on a before-tax basis. By incorporating personal taxes on the option, underlying share and dividend this paper shows that tax can potentially explain a large portion of early exercise events classified as 'irrational' in previous studies. Copyright (c) 2010 Blackwell Publishing Ltd.

Date: 2010
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Journal of Business Finance & Accounting is currently edited by P. F. Pope, A. W. Stark and M. Walker

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