Skip to content

IAI Actuarial Core Principles · Economic Modelling · Principles of option pricing

A European call option on a non-dividend-paying share has a strike price of Rs 500. All other factors are unchanged. Which single change would, on its own, lead to a fall in the call's value?

Raising the strike price to Rs 520 lowers the call's value, because the holder must pay more to buy the share and the payoff falls. Higher volatility, interest rates, time to expiry or share price each increase a call's value on a non-dividend-paying share.

  1. AAn increase in the share's volatility
  2. BAn increase in the risk-free interest rate
  3. CAn increase in the time to expiry
  4. DAn increase in the strike price to Rs 520Correct
  5. An increase in the current share price

Explanation

A call pays off when the share price exceeds the strike. A higher strike lowers the expected payoff and so lowers the call value. Higher volatility, a higher risk-free rate, longer expiry and a higher share price all raise the value of a call on a non-dividend share.

Did you get it right without looking?

One question tells you little. A timed set on Principles of option pricing shows your real accuracy, how long you take and where you lose marks.

Practise Principles of option pricingFree diagnostic mock

More Principles of option pricing questions