What are the factors that affect the value of the premium of an Option?

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There are 6 major factors that affect the value of the option premium:

  • Price of the underlying: When the price of the underlying increases the premium value of Call Option increases whereas that of Put Option decreases and vice versa.
  • Intrinsic Value of the option: It refers to the value of on option if it is exercised today and is calculated as the difference between spot and strike price of an option. An increase in intrinsic value decreases the value of Call option while increasing the value of Put Option.
  • Volatility of the underlying stock: The probability of price fluctuation of the underlying also affects the value of the Option. The higher the volatility, more will be the premium.
  • Time to expiration: The time left for an Option to expire also affects the premium. The closer the date of expiration, the lower the premium and vice versa.
  • Risk free interest rate: The prevailing interest rates in the country has indirect and nominal effect on the premium pricing. High interest rates means high premium and vice versa.
  • Dividends: The dividends announced by the company during the life of an Option also affects premium pricing. As per SEBI regulations, the Options prices are adjusted for non-dividend days when a dividend of more than 10% is announced. A higher dividend decreases the premium and vice versa.

Effect of market factors on call option price and put option price

Factor

Effect on Call Option Price

Effect on Put Option Price

Increase in the value of the underlying instrument

Increase

Decrease

Increase in intrinsic value

Decrease

Increase

Increase in Time Value

Increase

Increase

Increase in Volatility

Increase

Increase

Increase in Interest rates

Increase

Decrease

Increase in Dividends

Decrease

Increase

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