Question

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)

Answer 1

The following are the list of factors affecting the price the option and are used as important metrics in the option valuation

No	Factor	Description
1	Price of the underlying asset	The price of the underlying security and its valuation in the market determines its option premium
2	Time to expiration	Time time till expiry and the date of expiration methoned in the contract
3	The volatility in the market	The volaitiy of the market measure by the VIX index or appropriate volaitilty index
4	Cost of carrying the asset	The cost of carrying the security . It includes the holding charges and deducts any positive advantages paid during the period , live dividends
5	Strike Price	The strike price of the option
6	Prevailing Nominal interest rates%	The fluctuations in the risk free Rf rate in the market

2. Detailed description of the factors

1. Price of the underlying asset- The price of the underlying asset determines the price of the option premium . For exercising a call option ,it means giving the right to buy the underlying asset and vice versa for the put to sealing ta particular asset at a predermined price . As such the risk exposure de=pends on the actual settlement price of the underlying ,

Option pricing is proportionately related for the price of the underlying

2. Time to expiration- The higher the time to expiration, there are more chances that the volaitiy in the underlying wwill be high . As such the premium prices get higher on chosing a long distant option rater than an option expiring soon.

3. The volatility in the market – The higher the volatility in the market , more is the price for both the Call and puts issued in the F7O segment of the market. This is because there is a possibility of adverse price movements in both the direction.

4. Cost of carrying the asset- the cost of carrying the underlying asset also influences the option pricing as the cost of carry model,. This may include the charges levied for holding the securities.

However , any positive benefits like dividends issuance are proportionality deducted from the cost as these are positive benefits nd hence lowers the premium cost

5. Strike Price- The strike price is the excersice price written on the option contract , and at this price it gives the buyer right to exercise . Hence depending on whether the actual trading price or the sot price in In-the –money (ITM), At the money(ATM or Out of the money (OTM) the value of the option pricing depends,

6. Prevailing Nominal interest rates%-   finally the prevailing interest rates in the market also heaviliy influences the option pricing. This is because , if the risk ffree rate drops , it gives the investor the chance to borrow more at risk free and invest in equities leading the price of rise in the market . Hence the Call options gets higher in premium , compared to PUT .