All you want to know but never asked about the stocks and options markets.

jueves, 15 de enero de 2015

Premiun parameters in Options

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The premium, which reflects the value of the option, is quoted in the market and its value depends on various factors enumerated below:

- Price of the underlying asset.

- Exercise price of the option.

- Volatility.

- Interest rate on money market.

- Time remaining until maturity.

- Dividends (only for stock options).


First, with respect to the price of the underlying asset, we can say that the value of the Call option increases with the same, and the benefit of the option is calculated according to the following formula : Underying asset price - Exercise price, which means that options value increases when the underlying price rises. By contrast, the value of the Put option decreases as the underlying price rises, since the gain of the option is calculated using the following formula: Exercise price - price of the underlying asset.

Also, the lower the value of the exercise price the higher the value of the Call option because a lower exercise price allows to buy cheaper. In contrast, the higher the strike price, the greater the value of the put option, because a higher strike price allows to sell more expensive.

As regards the Time, in general terms the option premiums increase the longer the time to maturity, affecting exactly the premium through three variables:

a) Exercise price: In this case the longer the time before maturity, the lower the present value of the exercise price and, therefore, the higher the value of the Call option and the lower the Put option.

b) Volatility: the longer the time before maturity, the greater the possibility of movements in the underlying asset, which will mean an increase in both the premium of the Call options and the Put options.


c) Dividends (options on stocks): the longer the time to maturity, there is more chance of dividends, which affects negatively the Call options and positively the Put options.

Another parameter that certainly affect the price of the premium, is undoubtedly the volatility,  which is a measure of dispersion of the profitability of an asset and is defined as the standard deviation of returns. Thus, high volatility means that the price of the underlying asset ranges from a very wide range of values, while low volatility will mean that the asset price is slightly away from the median expected value.


Therefore, volatility is a measure of the risk of fluctuations in asset prices that will influence the option premium. Thus seen, the long positions of options benefit when volatility rises, because it implies a greater likelihood that these positions finish in the profit zone, and potential losses are minor and limited; while in the case of short positions, the trader profits when volatility falls as this ensure the income for the premium, the seller may charge if the option is not settled
The parameters of the premium will have the following impact on the value of call and put options:


Value Call Option Put Option
Exercise price Up Negative Positive
Down Positive Negative
Underlying Price Up Positive Negative
Down Negative Positive
Time to maturity Up Positive Positive
Down Negative Negative
Volatility Up Positive Positive
Down Negative Negative
Interest rate Up Positive Negative
Down Negative Positive


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