Question

In: Finance

Answer the following questions about option valuation. Construct a table to list the six factors affecting...

  1. Answer the following questions about option valuation.
  1. Construct a table to list the six factors affecting option value (including call and put option) and their relation (positive or negative) with option value. (10%)
  2. Explain why the six factors positively or negatively affect option value (Hint: Address the difference between the intrinsic value and the time value of the option). (15%)

Solutions

Expert Solution

(a)

Factor Factor change Call Option value Put Option value

1.Curent Market price

 Increase Increase(Positive relation) Decrease(Negative relation)
Decrease Decrease(Positive relation) Increase(Negative Rltion)

2.Strike price or exercise price

 Increase Decrease(Negative relation) Increase(Positive relation)
Decrease Increase(Negative Rltion) Decrease(Positive relation)

3.Time to expiry Or Time to maturity

 Increase Increase(Positive relation) Increase(Positive relation)
Decrease Decrease(Positive relation) Decrease(Positive relation)

4.Risk Free rate of interest

 Increase Increase(Positive relation) Decrease(Negative relation)
Decrease Decrease(Positive relation) Increase(Negative Rltion)

5.Volatility

 Increase Increase(Positive relation) Increase(Positive relation)
Decrease Decrease(Positive relation) Decrease(Positive relation)

6.Dividends

 Increase Decrease(Negative relation) Increase(Positive relation)
Decrease Increase(Negative Rltion) Decrease(Positive relation)

(b)

1.Current Market price-

Call option become more valuble as the stock prices rises and they become less valuable as the stock prices decreases.

In case of put option, it becomes more valuable as the stock price decreases and becomes less valuable as the stock price increases.

Current market price Increase Decreases
Call Option More valuable Less valuable
Put option Less Valuable More valuable

More valuable means more intrinsic value and more premium., or vise versa.

.

2.Strike price or exercise price-

Call option become more valuable as the strike prices decreases and they become less valuable as the strike increases.

In case of put option, it becomes more valuable as the strike increases and becomes less valuable as the strike prices decreases

Strike price or exercise price Increase Decreases
Call Option Less valuable More valuable
Put option More valuable Less valuable

3.Time to expiry Or Time to maturity-

Both the value of call and Put option increase in case the Time to expiry is more. Because in long life option contract more opportunities are opened.

4.Risk Free rate of interest-

Higher the risk free rate of interest ,higher the call option premium and lower the put option premium and vice versa.

Risk Free rate of interest Call option premium Put option premium
High High Lower
Lower Lower High

5. Volatility-

The higher the Volatility or Instability in the prices of an underlying asset, the higher will be the Option premium .

Because high volatility means , high risk and high risk means , high premium.

6.Dividends-

In case dividends are receivable before due dateof option and the current market price is Cum-dividend market price,hence after the record date , it will becpme ex-dividned and the market value will reduce.This results high option premium in case of Put option nad Low option premium in case of call option.

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

Answer the following questions about option valuation. Construct a table to list the six factors affecting...
Answer the following questions about option valuation. Construct a table to list the six factors affecting option value (including call and put option) and their relation (positive or negative) with option value. (10%) Explain why the six factors positively or negatively affect option value (Hint: Address the difference between the intrinsic value and the time value of the option). (15%)
Answer the following questions about option valuation. a. Construct a table to list the six factors...
Answer the following questions about option valuation. a. Construct a table to list the six factors affecting option value (including call and put option) and their relation (positive or negative) with option value. b. Explain why the six factors positively or negatively affect option value (Hint: Address the difference between the intrinsic value and the time value of the option).
1) Construct a table to list the six factors affecting option value (including call and put...
1) Construct a table to list the six factors affecting option value (including call and put option) and their relation (positive or negative) with option value 2) Explain why the six factors positively or negatively affect option value (Hint: Address the difference between intrinsic value and the time value of the option)
. Please answer the following conceptual questions related to factors affecting bond yields. a. Write out...
. Please answer the following conceptual questions related to factors affecting bond yields. a. Write out an equation for the nominal interest rate on any debt security. Briefly explain each factor and why is affects interest rate. b. Differentiate between interest rate risk and reinvestment rate risk. To which type of risk are holders of long-term bonds more exposed? Short-term bondholders? Explain. c. Why are U.S. Treasury bonds not riskless? To what types of risk are investors of foreign bonds...
The following questions use the table below on soybean oil. Answer the following questions about an...
The following questions use the table below on soybean oil. Answer the following questions about an end user needing to purchase soybean oil. One soybean oil contract is 60,000 pounds (lbs). Now Later Cash Soybean Meal Market $0.335/lb $0.346/lb Futures Soybean Meal Market $0.3000/lb $0.311/lb 1) Is the individual concerned about price increasing or decreasing? 2) What is the initial action in the futures market: buy or sell? 3) What is the cash price paid/received by the individual later? 4)...
Answer the following questions: You purchased six ABC $70 Dec 2020 put option contracts at a...
Answer the following questions: You purchased six ABC $70 Dec 2020 put option contracts at a quoted price of $2.50. What is your net gain or loss on this investment if the price of ABC is $68 on the option expiration date? Suppose that several rumors concerning ABC have circulated on the internet. These rumors have led to an increase in volatility in the stock. To take advantage of this situation, you decide to buy both a December put and...
Exercise 1 Construct an amortization table in Excel to answer the following questions. You must use...
Exercise 1 Construct an amortization table in Excel to answer the following questions. You must use the corresponding Excel financial formulas whenever possible. Upon graduation, Federico Hernández, borrows $20,000 to finance a late model used car. The loan is made by a family member who was able to obtain an 8 % annual percent rate (APR). The loan is going to be payback in equal monthly payments over 5 years. a) How much are the monthly payments? b) How many...
1. Answer the following questions about components of demand in GDP: a. List the components of...
1. Answer the following questions about components of demand in GDP: a. List the components of demand from the most important to the least important. b. What component of demand fluctuates the most? c. Why does the government share of demand appear (perhaps) surprisingly small?
Answer the following questions about financial derivatives. Address the similarity of forward, futures and option contracts....
Answer the following questions about financial derivatives. Address the similarity of forward, futures and option contracts. (5%) Address the differences between option and forward/futures contracts. (5%) Construct a table to address the differences between forward and futures contracts. (15%)
Fill in the table and answer the following questions
Fill in the table and answer the following questions **** (Use D-method) Class Frequency 10 – 12 6 13 – 15 4 16 – 18 14 19 – 21 15 22 – 24 8 25 – 27 2 28 – 30 1   50 Class Real limits f cf x d fd     10 – 12                 13 – 15                 16 – 18  ...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT