How do dividends create a case for early exercise of American calls?

Question

AcadiFi · Accepted Answer

On a non-dividend stock, an American call is never optimally exercised early because C_american >= S - K*e^(-rT) > S - K = intrinsic, meaning you always get more by selling the call than exercising. Dividends break this inequality because holding the call means you don't receive the dividend, while exercising converts to stock which does.

Rule of thumb: consider exercising an American call immediately before an ex-dividend date if the dividend D exceeds the time value of the call for the remaining period, specifically when D > K*(1 - e^(-r*t)), where t is time from ex-date to expiry.

Example: Ibex Semiconductor trades at $180 with an American call strike $150 expiring in 90 days. An ex-dividend date is tomorrow with D=$3.50. Remaining time from ex-date to expiry is 89 days, r=5%. Threshold: 150*(1 - e^(-0.05*89/365)) = 150*0.01213 = $1.82. Since D=$3.50 > $1.82, exercise just before ex-date.

```mermaid
flowchart LR
  A[Ex-div approaches] --> B{D > K*(1-e^-rt)?}
  B -->|Yes| C[Exercise before ex-div]
  B -->|No| D[Hold call]
```

In practice, only the LAST ex-dividend date before expiry typically triggers early exercise since earlier dividends leave more time value. Multiple dividends require checking each threshold sequentially.

How do dividends create a case for early exercise of American calls?

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