Question

19. Which of the following is true regarding the value of an option?

A) Unlike the Black-Scholes formula, the Put-Call Parity suggests that the volatility of underlying asset is not a factor that affects the value of an option.

B) The call and put premiums are unrelated since they depend on different set of variables.

C) The writer of the call option pays the same premium as the buyer of the put option.

D) When the call option is out-of-the-money and the put option is in-the-money, the call must be more valuable than the put.

E) The option premium is greater or equal to its intrinsic value because of the time premium.

Answer 1

Answer: Option (E)

The option premium is greater or equal to its intrinsic value because of the time premium.

Option Premium = Intrinsic Value + Time Value premium.

As the time to expiry reduces, Time premium gradually approaches zero, at the time of expiry Option Premium wil be equala to the Interinsic value.

Other Options:

A. Put-Call Parity suggests that the volatility of underlying asset is not a factor that affects the value of an option, As per Put Call Parity Theorem, S_o + P = C + K*e^-rt

As per the Put Call Parity Theorem, In the absence of dividends or other costs of carry, the implied volatility of calls and puts must be identical.

B. As per Put Call Parity Theorem, The call and put premiums are related since they depend on same set of variables(Spot Price(S_o), Strike Price (K), Interest Rate (r), Time to Expiry(t)).

C. The writer of the call option does not pay the premium rather he recieves the premium from buyer of call option, for giving him the right to buy at the predetermined price. Buyer of the put option has to pay premium for taking right to sell at the expiry.

D. When the call option is out-of-the-money and the put option is in-the-money, the Put must be more valuable than the Call.

Option Premium = Intrinsic Value + Time Value premium.

If the option is Out of Money, Option will not be exercised as the Intrinsic value of the option becomes zero.

When the option is In the money, In-the-Money, Option will be exercised as the Intrinsic value of the option will be positive.

i.e., As the call option is out-of-the-money, the intrinsic value of option will be near to zero, while the put option is in-the-money, the Put must be more valuable than the as it has the intrinsic value.