Let’s look at the impact of exercise price and time to expiration on option prices. Exercise Price The price of a put option increases with the increase in exercise price. This is because the put option holder can sell the stock at a higher price. The price of a call option increases with the decrease […]

# Option Valuation

## Minimum and Maximum Value of European/American Options

Lower Bound We know that the value of an option is equal to the sum of its intrinsic value and time value. Since an option cannot sell below its intrinsic value, its value cannot be negative, Therefore, the lower bound for both American and European options is zero. Upper Bound Call Options A call option […]

## Put Call Parity in Options

The payoff profile of the options can be used to create more complex positions. A long position in the underlying asset can be decomposed into a long call plus a short put with the same strike price and maturities. Pay on purchase of a call option is as follows: Pay on sale of put option […]

## Put Call Parity and Arbitrage Opportunity

In this article, we will look at how we can seek arbitrage opportunities by using the put-call parity equation. As we know, the put-call parity equation is represented as follows: c + PV(K) = p + s If the prices of put and call options available in the market do not follow the above relationship […]

## Should American Options be Exercised Early?

As we know, unlike a European option, the holder of an American option can exercise the option before the expiry date. Because of this additional benefit of being able to exercise the option early, an American option is always more expensive than a European option. However, is this benefit of any real use, that is, […]

## How Interest Rates and Volatility Affect Option Prices?

Both interest rates and underlying stock’s volatility have an influence on the option prices. Impact of Interest Rates When interest rates increase, the call option prices increase while the put option prices decrease. Let’s look at the logic behind this. Let’s say you are interested in buying a stock which sells at $10 per share. […]