An empirical study on the early exercise premium of American options: Evidence from OEX and XEO options

Abstract

Since the S&P 100 Index underlies both American (OEX) and European (XEO) options, the value of the early exercise premium of American options can be directly observed. We find that the mid-quote of an XEO option can be higher than that of an otherwise identical OEX option, and liquidity can explain this overpricing phenomenon of European options. Our results show that illiquid options are significantly overpriced in the S&P 100 Index options market. This finding indicates that an illiquid option can be overvalued with a higher market offer price, which is the requirement of market makers for compensation for providing liquidity.