- Volatility of price in the underlying (most influential)
- Price of the underlying
- Exercise price
- Risk-free rate
- Time to expiration
- Holding costs.
Volatility becomes the most important of the six factors because if there were no volatility in the price of the underlying asset, i.e., price was either always known or it remained constant, then the option would always be equal to the intrinsic value of the underlying asset. The second most influential factor is the time to expiration for American Style options. Because volatility is measured in units of time, the longer the amount of time an option is held, the more accumulated volatility it has, thus adding value to the time to expiration. Said differently, duration of shorter time to expiration have lower time value because there is less presumed volatility.
The following Table summarizes the factors that affect the value of an option and the respective effect to a Put or Call option’s value.
Increase in following factors | Call Value | Put Value |
Stock Price | ↑ | ↓ |
Strike (Exercise) Price | ↓ | ↑ |
Variance of underlying asset | ↑ | ↑ |
Time to expiration (N/A to European option) | ↑ | ↑ |
Interest rate | ↑ | ↓ |
Dividends paid | ↓ | ↑ |
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