Suppose that Nielson Motors stock is trading for $50 per share and that Nielson pays no dividends. What is the minimum possible price for an American put option on Nielson Motors with a strike price of $70?
A) $0
B) $20
C) $50
D) infinite
B
Explanation: B) P = K - S + C - dis(K) where K - S is the intrinsic value and C - dis(K) is the time value. Since the American option can be exercised early, it should never have a negative time value. Therefore its minimum price should be equal to its intrinsic value of K - S = $70 - $50 = $20
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