36 lines
2.6 KiB
Plaintext
36 lines
2.6 KiB
Plaintext
14 Part I: Basic Properties ol Stodc Options
|
||
stock has the ability to move a relatively large distance upward, buyers of the calls are
|
||
willing to pay higher prices for the calls - and sellers demand them as well. For exam
|
||
ple, if AT&T and Xerox sell for the same price (as they have been known to do), the
|
||
Xerox calls would be more highly priced than the AT&T calls because Xerox is a more
|
||
volatile stock than AT&T.
|
||
The interplay of the four major variables - stock price, striking price, time, and
|
||
volatility can be quite complex. While a rising stock price (for example) is directing
|
||
the price of a call upward, decreasing time may be simultaneously driving the price
|
||
in the opposite direction. Thus, the purchaser of an out-of-the-money call may wind
|
||
up with a loss even after a rise in price by the underlying stock, because time has
|
||
eroded the call value.
|
||
THE TWO MINOR DETERMINANTS
|
||
The Risk-Free Interest Rate. This rate is generally construed as the current
|
||
rate of 90-day Treasury bills. Higher interest rates imply slightly higher option pre
|
||
miums, while lower rates imply lower premiums. Although members of the financial
|
||
community disagree as to the extent that interest rates actually affect option price,
|
||
they remain a factor in most mathematical models used for pricing options. (These
|
||
models are covered much later in this book.)
|
||
The Cash Dividend Rate of the Underlying Stock. Though not clas
|
||
sified as a major determinant in option prices, this rate can be especially impor
|
||
tant to the writer (seller) of an option. If the underlying stock pays no dividends
|
||
at all, then a call option's worth is strictly a function of the other five items.
|
||
Dividends, however, tend to lower call option premiums: The larger the dividend
|
||
of the underlying common stock, the lower the price of its call options. One of
|
||
the most influential factors in keeping option premiums low on high-yielding
|
||
stock is the yield itself.
|
||
Example: XYZ is a relatively low-priced stock with low volatility selling for $25 per
|
||
share. It pays a large annual dividend of $2 per share in four quarterly payments of
|
||
$.50 each. What is a fair price of an XYZ call with striking price 25?
|
||
A prospective buyer of XYZ options is determined to figure out a fair price. In
|
||
six months XYZ will pay $1 per share in dividends, and the stock price will thus be
|
||
reduced by $1 per share when it goes ex-dividend over that time period. In that case,
|
||
if XYZ's price remains unchanged except for the ex-dividend reductions, it will then
|
||
be $24. Moreover, since XYZ is a nonvolatile stock, it may not readily climb back to
|
||
25 after the ex-dividend reductions. Therefore, the call buyer makes a low bid - even |