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In this paper, a new combination of time and spatial discretization is proposed for a partial integro-differential equation (PIDE) arising in the valuation of European options under Merton's model. We first present a high-order compact (HOC) difference scheme in space based on a uniform mesh to obtain a highly accurate result, and the discontinuous Galerkin (DG) finite element method in time is introduced that can deal with the loss of the time analyticity. A penalty method is proposed for a partial integro-differential complementarity problem arising in the valuation of the American put option. Numerical experiments are performed to verify the accuracy and efficiency of the proposed method.

Numerical valuation of European and American options under Merton's model