Answer and explain the following: A. If you decrease a put option exercise price

Question

Answer and explain the following:

A. If you decrease a put option exercise price by $1, would the value of the option increase or decrease, and by more or less or the same as $1?

B. All else equal, will an option on a high beta stock be priced higher or lower than a low beta stock?

C. All else equal, will an option on a company with high firm-specific risk be priced higher or lower than a firm with low firm-specific risk?

D. All else equal, will an option with a higher exercise price have a higher or lower hedge ratio and an option with a low exercise price?

Explanation / Answer

A.) If we decrease the Put option price by $1, the option price will increase or decrease depending on whether the option is purchased at In the Money or Out of Money respectively. The change will not be same as $1 change because the option price also includes other factors such as volatility and time to expiry.

B.) A high beta stock will have higher volatility and hence the option price of higher beta stock will be priced higher than lower beta stock with other factors remaining the same.

C.) A firm with higher risk will have higher cost of capital. This will result in lower stock price considering the higher expected return by its investors. Option price depends on the current stock price and hence the option price for firm with higher risk will be higher as compared to firm with low risk.

d.) An option with higher price will have a lower hedge ratio than an option with low exercise price. This is because the option price movement (indicated by its delta) for strike price which is closer to the underlying price will be more than the strike price which is farther.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.