Question

1. Explain the effect of time to expiration on call and put premiums.   Explain 3 different ways the time value of an option can be zero.
2. What are the lower bounds for both American and European calls and puts?   Compare the lower bounds for both the American and European calls and the American and European puts. Which ones are the same and which ones are different? Explain why.

Answer 1

Effect of time to expiration on call and put premium will be that when there will be a higher time to expiration then there will be a higher put premium and call premium due to time effect on the option valuation, but when there would be a lower time left for expiration then these Time premium will be decaying because investor will be having a lower time to exercise their options.

Time value of an option can be zero on the maturity, and time value of option can also be zero when the options has been exercise early by the trader and when options had been trading at a price zero before expiry due to high degree of pessimism.

Lower bounds of American call options andEuropean call option as well as American put option and European put option will be zero because these options can not with trading in negative.

lower bounds of all the American call option and European call option along with American put option and European put option cannot be going below zero and trading in negative so the lower Bond will always be equal to zero and hence it can be said that every option according to American call option or European call option or American put option or European food option will be having a lower bound of zero and they are having a similar lower bound because they can never slide below zero.