Question

3. Pick three things that affect the value of options and explain why they affect the value of options the way they do. (9 pts.)

Answer 1

There are two types of option: call and put. The facors which affect value of options are:-

i) Exercise price = It is the price which has direct relationship with put option and indirect rrelationship with call option. If the excersice price increases or is higher than stock price , then only put option is exercised and have value. In case of call, the lower the exercise price, higher the value.

ii) Stock price = It refers to the current Price of the stock. A call option is exercised , when the stock price is more than strike price. The higher the difference between the stock and strike price , higher is the value of call option. Whereas , if the stock is more than strike , then the value of put is zero as it is not exercised. So, put option is inversely proportioned to stock price.

iii) Risk free rate:- The risk free rate is directly proportional to call option and inversely to put option. In case of call option, we have the money and not the stock , so the money can be used to earn risk free rate until the stocks are not brought. Higher the risk free rate , more the value of call Option. In case of put option we have the stock and not the money, so we lose out on risk free rate. Hence put option has higher value when risk free rate is low and lower value when risk free rate is high.