Howdy, Stranger!

It looks like you're new here. If you want to get involved, click one of these buttons!

CFA Events Calendar

View full calendar

Recommended Discussions

See how our partners can help you ace your CFA exams.

Question of the Week - Derivatives

AdaptPrepAdaptPrep Des Moines, IA, USAPosts: 211 Sr Associate
edited December 2015 in Level 1 Questions
Which of the following is most likely to cause an increase in option price?
PassedTense
Level I:  Adapt Exam Engine + Video Lessons + Study Manual
Level II: Adapt Exam Engine + Video Lessons
Level II: Coming 2016

Free Trial with mock exam!
www.passedtense.com

Question of the Week - Derivatives 27 votes

Higher exercise price for an American put
62%
AdaptPrepgoogs1484TipzenajnoakesclangerhitsalwayslupusJackass5carlfoxBpo44scarebaerBeregondalexlj92mdlynch3MrTsotnesramanspabulumsBlueJay3535 17 votes
Higher exercise price for a European call
14%
LukeDemjenBaz_DOLUSEGUNavannoord 4 votes
Shorter time to maturity for an American call
22%
ArsenalFancamel717paulopitaSafiBpo44mukta 6 votes

Comments

  • AdaptPrepAdaptPrep Des Moines, IA, USAPosts: 211 Sr Associate
    Higher exercise price for an American put

    A put option is the right to sell a security for $X, where X is the exercise price. It logically follows that the right is likely to become more valuable if X increases.

    A call option is the right to purchase a security for $X, where X is the exercise price. It logically follows that the right can't become more valuable if X increases.

    American options (both calls and puts) are generally worth more (and never worth less) as time to maturity lengthens, because the lengthening simply expands the right of the option owner to exercise.

    PassedTense
    Level I:  Adapt Exam Engine + Video Lessons + Study Manual
    Level II: Adapt Exam Engine + Video Lessons
    Level II: Coming 2016

    Free Trial with mock exam!
    www.passedtense.com

  • scarebaerscarebaer Denver - COPosts: 15 Associate
    Higher exercise price for an American put
    I personally think this questions i poorly asked. But nevertheless my logic follows. 

    First off we can throw out answer C after reading the question. If an option has a shorter time to maturity, it inherently has less "time" premium to it. (you can also think of this as the greek theta towards expiration. IE theta increases the less time there is to exp. Less chance to finishing in the money.)

    Now all else equal, stock price, strike ETC. Let's give an example.

    Stock = $10 The straddle of the 10 strike is worth $1 and the C and P are worth the same value (not taking into account Div or Int in this example).  If we change the exercise price, or essentially our strike price to 11 holding the price of the stock, vol time to ex the same. What is reflective of the value of the Put and the call now at a higher ex price? Well Let's just say our put is now worth 1.10 ($1 ITM and .10 time premium). And our call is worth .10. Therefore holding all else equal the Inc in strike price the value of the put is increased while the call is decreased. 

    Side note 1. If we say our Put is worth 1.10 how do we know the call is worth .10? Put-call parity. IE Value of a call = P + Stockprice - strike price - (divs - int) . IE x = 1.10 + 10 - 10 - 0. = .10

    P = call + strike - stock + (divs - int)

    Side note 2 The value of Am vs euro options. Am > Euro given the right to early ex for Int and Divs. 

    Source: work as options trader 
Sign In or Register to comment.