FRM Part I · FRM Exam Part I · Properties of Options
Holding all other inputs constant, which change would increase the value of a European put option on a non-dividend-paying stock?
An increase in the stock's volatility raises the value of a European put. Option payoffs are asymmetric, so greater price variability increases expected payoff without increasing the holder's maximum loss, which is the premium paid. Higher rates reduce put values, and lower volatility also lowers them.
- AA decrease in the stock's volatility
- BAn increase in the risk-free interest rate
- CAn increase in the stock's volatilityCorrect
- DA decrease in the time to maturity from 2 years to 1 year
Explanation
Higher volatility raises the chance of large favourable moves while the downside to the holder is limited to the premium, so both calls and puts gain value. A higher risk-free rate reduces put value because the present value of the strike falls. Lower volatility reduces value. Shortening maturity generally reduces a European put's value only in typical cases and is not a certain increase.
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