Question

What would happen to the premium for an at-the-money call option, an at-the-money put option, and an in-the-money call option on a stock if:

a. the stock's price jumps 15%?

b. a month passes with very little change to the stock's price

c. the firm issues an earnings report with no impact on the spot price

d. there is high volatility for the stock

Answer 1

At-the-money call option

a. the stock's price jumps 15%

The premium increases as the probability of the call option expiring in the money increases.

b. a month passes with very little change to the stock's price

The premium decreases as the option is at the money and the shorter time to maturity decreases the probability of the option going above the strike price, thus limiting the upside payoff potential

c. the firm issues an earnings report with no impact on the spot price

This would have a no impact on the call option price as the information didn't affect the spot price.

d. there is high volatility for the stock

Higher the volatility, higher the chances of the option expiring in the money. Since there is a limited downside, the upside potential is infinite, high volatility will increase the call option price.

At-the-money put option

a. the stock's price jumps 15%

The premium decreases as the probability of the put option to expiring in the money decreases.

b. a month passes with very little change to the stock's price

The premium decreases as the option is at the money and the shorter time to maturity decreases the probability of the option going below the strike price, thus limiting the upside payoff potential

c. the firm issues an earnings report with no impact on the spot price

This would have no impact on the put option price as the information didn't affect the spot price.

d. there is high volatility for the stock

Higher the volatility, higher the chances of the option expiring in the money. Since there is a limited downside, the upside potential is infinite, high volatility will increase the put option price.

In-the-money call option

a. the stock's price jumps 15%

The premium increases as the probability of the call option expiring even higher in the money increases.

b. a month passes with very little change to the stock's price

The premium decreases as the option is already in the money and the shorter time to maturity decreases the probability of the option going further above the strike price, thus limiting the upside payoff potential

c. the firm issues an earnings report with no impact on the spot price

This would have a no impact on the call option price as the information didn't affect the spot price.

d. there is high volatility for the stock

Higher the volatility, higher the chances of the option expiring in the money. Since there is a limited downside, the upside potential is infinite, high volatility will increase the call option price.