An American Call Is Worth More Than a European Call: The Value of American Exercise When the Market Is Not Perfectly Liquid

Stephen Figlewski

Journal of Financial and Quantitative Analysis, 2022, vol. 57, issue 3, 1023-1057

Abstract: Theory says an American call should never be exercised early, except possibly just before an ex-dividend date. But the best market bid is regularly lower than the intrinsic value for in-the-money short-maturity options. An American option can always be exercised to recover the intrinsic value, whereas selling a European call in the market may return considerably less. The article derives the liquidity value of American exercise in closed form as a function of the bid–ask spread and shows empirically that it is of comparable magnitude to, and often greater than, the theoretical value of American exercise to collect a dividend.

Date: 2022
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