medium · FRM Part 1 Financial Markets and Products
For an American put option, the lower bound is defined as P ≥ max(K - S_0, 0).
Why is this bound higher than the lower bound for a European put (p ≥ max(Ke^-rT - S_0, 0))?
- The risk-free rate for American options is always higher than for European ones.
- The American put is always affected by dividends more than the European put option is.
- The American put can be exercised immediately to receive the full intrinsic value.
- European puts are used only for hedging purposes, which reduces their overall market value.
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