Skip to content

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

A share is expected to pay a large dividend before the expiry of two options on it, a European call and a European put. Compared with an otherwise identical share paying no dividend, what is the effect on the current option values?

The call is worth less and the put is worth more. The dividend reduces the share price when paid and option holders do not receive it, so the expected future share price falls, hurting calls and helping puts.

  1. AThe call and the put are both lower
  2. BThe call and the put are both higher
  3. CThe call is lower and the put is higherCorrect
  4. DThe call is higher and the put is lower
  5. Neither changes, because option values depend only on the current share price

Explanation

The dividend lowers the share price on the ex-dividend date and the option holder does not receive it. A lower expected future share price reduces the call value and increases the put value. Put-call parity with the present value of the dividend deducted from S shows the same effect.

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