Determinants of option value
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The following components determine the value of an option:
- Variables Relating to Underlying Asset
- Value of Underlying Asset
- as this value increases, the right to buy at a fixed price (calls) will become more valuable and the right to sell at a fixed price (puts) willbecome less valuable.
- Variance in that value
- as the variance increases, both calls and puts will become more valuable because all options have limited downside and depend upon price volatility for upside.
- Expected dividends on the asset
- Which are likely to reduce the price appreciation component of the asset, reducing the value of calls and increasing the value of puts.
- Value of Underlying Asset
- Variables Relating to Option
- Strike Price of Options; the right to buy (sell) at a fixed price becomes more (less) valuable at a lower price.
- Life of the Option; both calls and puts benefit from a longer life.
- Level of Interest Rates; as rates increase, the right to buy (sell) at a fixed price in the future becomes more (less) valuable.