How Does Early Exercise Affect the Pricing of American Options?

The ability to exercise an American option before expiration adds a layer of complexity and value compared to a European option. This early exercise right means an American option's price will always be greater than or equal to its European counterpart.

In practice, early exercise is generally only rational for American Call options on dividend-paying stocks or American Put options. The potential for early exercise is incorporated into more complex pricing models like the binomial model.