Question

1. For each event, describe what you think would happen to the premium for both an at-the- money call option and an at-the-money put option on a stock.

   1. [5] The stock’s price rapidly jumps 10%.

   2. [5] A week passes with very little change to the stock’s price.

   3. [10] The spread of COVID-19 creates high volatility for the stock (though on average the

      price is largely in line with the pre-COVID trend).

   4. [Extra Credit, 5] The firm issues an earnings report which has no impact on the spot

      price (i.e. in line with expectations).

Answer 1

1. As the premium of Call option increases with increase in the price of security and the premium of Put option decreases with increase in the price of security

The At the money call option premium will increase sharply

The At the money put option premium will decrease sharply  

2. After a week passes with little change in stock price, the call option premium will decrease with the passage of time , as it loses time value

Similarly, put option premium will also decrease with the passage of time as it loses time value.

3. Increase in Volatility of stocks increases the premium of both the call and the put options. Hence both the At the money call option and the put option should experience an increase in premium

4. Earnings report which is in line with expectations and do not influence spot price should also not influence the premiums of options. So, there should be no change in the premiums of the call and the put options