Lesson 6 of 6 · All lessons in this module
  1. Payoff at expiration and exercise value before it
  2. Moneyness: in, at and out of the money
  3. Time value and time value decay
  4. Arbitrage: forwards versus options, and option price boundsVideo lesson
  5. Replication: forwards versus options
  6. Factors that determine an option's valueVideo lesson

Lesson 6 of 6 · 14 min

Factors that determine an option's value

Six factors drive option value; volatility and time usually push calls and puts the same way, while the underlying price, exercise price, interest rate and carry benefits or costs push them in opposite directions.

In short

  • Factors: value of the underlying, exercise price, time to expiration, risk-free rate, volatility of the underlying, and income or cost of owning the underlying.
  • Higher underlying price: call up, put down. Higher exercise price: call down, put up.
  • Longer time to expiration: call up; put usually up, but sometimes down (deep ITM puts, high rates).
  • Higher risk-free rate: lowers PV(X), so call up, put down. It does not directly affect time value.
  • Higher volatility: both call and put up.
  • Income or benefits from the underlying (dividends, convenience yield): call down, put up. Carry costs (storage, insurance): call up, put down.

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