Factors Driving Option Prices
If you are into option trading, then you need to be aware of the various factors that influence the option prices. Several factors hold the potential to influence the option prices. They play significant roles in determining the value of call and put options. Hence, if you need to know the actual price of an option, you have to consider a plethora of factors. As a result, when you buy or sell options, you can find out the appropriate price.
Various factors determine the price of options. Let’s have a look at some of the key elements that have a say in the option prices.
The spot price represents the present value of the underlying asset. It has an important role to play in deciding the option price. Therefore, fluctuations reflected in the spot price influence the value of the call and put options. If the value of the underlying instrument experiences a rise, then the price of the call option tends to rise. Meanwhile, the price of the put option will go down.
The strike price is the price at which you can buy or sell a derivative contract. The strike price is positioned with the current price of the underlying assets. It affects the value of an option. Therefore, it affects the price of an option.
In situations where all the other factors remain stable, a rise in the strike price of options affects the value of the call option and put option. Accordingly, the call option’s value takes a downward path and the put option’s value tends to go up.
Conversely, if all other factors stand still, a dip in the option’s strike price translates into an increase in the call option’s price. Likewise, the put option’s price displays a decreasing trend.
Interest rates do play a part in determining the option prices. As interest rates show an upward surge, the call option price usually rises. This is because, when a trader selects the call option over stock, the additional cash in his wallet should earn him interest. This is a theoretical concept. Hence, we cannot say that it holds true for the real world. This fact speaks about the impact of interest rates on option values.
In essence, higher interest rates have the capacity to increase option prices. Thus, becoming a contributing element in the option pricing landscape.
Options have a fixed lifespan and they expire after a defined date. Therefore, the period before expiry is significant for all options. Consequently, the amount of time before expiration positively impacts the value of options. When there is more time, chances for more profitable moves are plenty.
Dividends play a pivotal role in option prices. When a dividend is declared by a company, it influences the price of both put and call options.
The announcement of dividends has a negative impact on the call option price. It usually decreases the call option price. This is because, on the ex-dividend date, the stock's value tends to go down by the amount of the dividend. As a result, the call option’s potential upside decreases.
On the other hand, with the announcement of dividends, the value of the put option goes up. On the ex-dividend days, when the stock prices drop, put options seem alluring. This is because the holder can sell the stock at a higher value.
Volatility is a term that denotes the regular upward and downward fluctuations in stock prices. It is one of the various factors that shifts the direction of option prices. Hence, it affects both call and put options. When the underlying stock shows increased volatility, the option price increases. It happens because the option tends to move in the money throughout the duration of the contract.
In essence, if there is higher volatility, it results in higher prices for call as well as put options. Similarly, if the volatility is comparatively less, then both call and put option prices will decrease.
The interplay of various elements shapes the dynamic landscape of option prices. Any change in these factors will influence option prices. Therefore, track these elements regularly. It will help you to make informed decisions when it comes to option prices. JBIS Securities can help you learn all these factors through our Stock Market Mentorship Transformation Program to become a successful stock market trader.