Question

What effect does Stock Price have on call option price?

What effect does Time expiration have on call option price?

What effect does Risk-free rate have on call option price?

What effect does Standard Deviation of Stock returns have on call option price?

Answer 1

Solution:

As the stock price increases the call option price increases and as the stock prices decreases the call option prices also decreases. This is because a higher share price means a higher intrinsic value which in turn means a higher premium.

The longer the time to expiry, the greater the chance that the underlying share price can move significantly in favour of the holder of the option before expiry. So the value of an option will increase with term to maturity. Hence, longer the time to expiry the higher the option price and shorter the time to expiry , the lower the option price.

An increase in the risk free rate of interest will result in a higher value for a call option because the money saved by purchasing the option rather than the underlying share can be invested at this higher rate of interest, thus increasing the value of the option. Therefore if the interest rate rises, the call option price increases and if the rate decreases the call option price also decreases.

The higher the standard deviation of the stock( i.e volatility) the greater the chance that the underlying share price can move significantly in favour of the holder of the option before expiry. So the value of an option will increase with the increase in standard deviation of the stock. Hence greater the standard deviation of the stock greater the call option price and vice versa.