the value of a European call option is positively (directly) related to:
a. exercice price
b. underlying price.
c. volatility of the underyling
It’s pretty clear that it won’t be the answer a (the call option will be less attractive if you could buy the underlying for a higher price, therefore it’s indirectly related), but regarding the others two, I thought they were directly related?
I thought the following: if the underlying price increases, the value of my call option will increase as well (I will have the possiblity to buy an asset “even cheaper” and sell it a higher price).
For the volatility (which is the correct answer), I know that it’s beneficial to both call and put (will give more possibility to eventually exercice an option).
Aren’t the answers b and c directly related to the price of a call option (European)?
This may not be the answer, but this is what I think.
Maybe B is wrong because it refers to the underlying asset’s price at t=0.
The underlying’s price AT MATURITY should be more important.
If the volatility of the underlying is high, then there is more probability for the price of the underlying AT MATURITY to be higher than the strike price, even if it means the volatility of the underlying at t=0(assuming that the volatility of an underlying asset does not change over the period).
Suppose the call is deeply out-of-the money and there is little time before expiration. The level of the price of the underlying will not change much to the price of the call.
For instance: Your strike price is 100 and your underlying is worth 1 and there is no chance that it will reach 100 before expiration in one hour. The call’s value won’t be affected by an increase up 50 in the underlying price.
It is lame but I don’t see how to exclude the underlying price .
Maybe you could ask a heavy-hitter like S2000 magician to weigh in.
I checked my Schweser notes and came across a possible answer.
If a call is deep out of the money its delta (sensitivity to change to the underlying price) will be close to zero. If the price increases slightly the effect on the call value will be minimal (close to zero X close to zero = very close to zero).
In a sense (not in a mathematical one but in a practical one), higher underlying price will not result in a higher call price.
If you bought a call option when vola of the underlying was high - you paid a certain premium for that. If you hold that call and the price of the underlying goes up - but slow and steady -(meaning volatility of the underlying has decreased), the price of your call will decrease, even though the price of the underlying is moving in the right direction. Hope it helps!
thanks you for your comment. Even it the price increase was slow and steady, why would the value of my call decrease? Plus the curriculum states that “The value of a European call option is directly related to the value of the underlying… this make the whole thing a bit… difficult to understand
A simplified example: Lets say an underlying stock has a daily movement of 0,5%.
The stock currently trades @ 100
You buy a a european call with a strike price @ 120 maturing in 6 Month.
On day 1 the stock drops 10%. On day 2 the stock rises 10%.
The stock price is now 99 (100*0,9*1,1=99), which is 1 % lower than when you bought your call. So if there were a direct relation with the price of the underlying your call option would be cheaper today than it was on the day you bought it when the stock traded at 100.
But in reality your call price is now higher! Why? because with 10% swings the chances are higher that your call will be in the money in 6 months.