The value of which of the following options cannot be less than its intrinsic value

The value of which of the following options cannot be less than its intrinsic value
A . a Bermudan put
B . a European put
C . an American put
D . a European call

View Answer

Answer: C

Explanation:

Note that intrinsic value of an option is the difference between the value of the underlying and the strike price of the option.

European options can only be exercised at expiry, and Bermudan options only at certain dates during the life of the option. Therefore the option may be valued at less than intrinsic value if the earliest possible exercise date is not very close. An American option however can be exercised at any time prior to expiry, which means that its value can never fall below its intrinsic value. Because if it did, arbitrageurs would buy the option and immediately exercise it to get a risk free profit. It does not matter whether the option is a call or a put – therefore the correct answer is Choice ‘c’.