Put Option Question?

Question

Hi friends, need your help on this!

How does the price of a put option respond to the following changes? Indicate whether or not the price will go up or down and briefly explain your answer.

(a) Stock price increases,

(b) Exercise price is increased,

(c) Expiration date of the option is extended,

(d) Volatility of the stock price falls,

(e) The expiration of the option approaches.

Many thanks!

Answer 1

<<<(a) Stock price increases,>>>

Long puts have a negative delta so the price would decrease.

<<<(b) Exercise price is increased,>>>

The exercise price is fixed and cannot be increased. A put with a higher exercise price will be higher priced than a put with a lower exercsie price. If that were not true a risk free profit could be obtained by buying the put with the higher exercise price and selling the put with the lower exercsie price.

<<<(c) Expiration date of the option is extended,>>>

The exercise date is only extended when trading is suspended on the original exercise date. If you are talking about American-style options the put with a later expiration date is always worth at least as much as the put with an earlier expiration date. If you are talking about European-style options, the carrying costs may be high enough that the options with a later expiration date is less expensive. This is commonly seen with deep in the money puts on indexes. This reversal of the normal pattern is called backwardation.

<<<(d) Volatility of the stock price falls,>>>

For exchange traded options the volatility of the stock price has no direct impact on the price of the option. The volatility of the stock price may indirectly impact the price of the option by changing the implied volatility of the option. Most commonly an increase in the volatility of the stock price will increase the implied voaltility of the options and thereby increase the price of both the puts and calls. However, there could be a situation such as a takeover that increases the volatility of the underlying stock but decreases the implied volatility, thereby lowering the price of both put and call options.

<<<(e) The expiration of the option approaches.>>>

Normally this would decrease the price of the option. However if carrying costs are high, such as with a deep in the money European-style option on an index, it could increase the price of the put option due to backwardation.