Question

Explain briefly the factors determining the prices of the options

Answer 1

Factors determining the price of the option are :

1.Interest Rates – This is really a small factor in determining an option’s price. When interest rates are on the rise, the value of call options rise as well. If a trader decides to buy a call option instead of stock, then the extra cash they have should theoretically earn interest for them. While this doesn’t necessarily work so easily in the “real world” the theory behind it does make sense.

2. Dividends – If a stock trades without giving the stockholder any dividend, it is said to be ex-dividend and its price goes down by the dividend amount. As dividend increases, puts are worth more while calls are worth less.

3. Volatility – The big variable right? In very simple terms, volatility measures the difference from day to day in a stocks price. I think of it as the “swings” that a stock has. Does it move back and forth violently or trading in a defined range with little daily movement?Stocks that are volatile go through more frequent strike price levels than the non-volatile stocks. With these big moves, you have a higher chance of making money (i.e. moves outside the Blue area).

Thus an option on a volatile stock is much more expensive than one on a less volatile stock. Remember that even a small change in the volatility estimate can have a big impact on an options price.

4.Days Until Expiration – Options have a definitive life because of expiration. Therefore, an option will increase in value with more time. Why? Well, the more the time until expiration, the greater the probability or chance of a profitable move.

5. Type of Option – The value of an option depends on which type it is: Call or Put. Clearly there would be a difference depending on which side of the trade and market you are on. This probably is the easiest variable to understand

6.Strike Price – This is the price at which a call owner may purchase stock, and the put owner may sell stock.calls become more expensive as the strike price moves lower. Likewise, puts become more expensive in value as the strike price increases.