I can see why the higher the carrying costs make a call option more valuable( you don’t hold the asset and don’t get charged the costs) but why are puts less valuable when storage costs are higher?
Because you have to store the asset when, in effect, it is no longer yours.
S2000magician - can you please explain this further? What do you mean? You still own the Put until you exercise it. Thanks.
When the cost of carry is negative (i.e. costs of holding an asset exceeds income received while holding the asset) and arbitrage pricing holds, the forward price will be above the spot price. Since puts give the holder the right to sell at a fixed price, the lower the price the asset the put holder has the right to sell at the option’s strike price, the more valuable the put. The higher the value of the underlying, the less valuable the put.
Carrying charges or the “costs” of carry includes financing cost (or opportunity cost of capital), storage costs and insurance. For commodity options (e.g. crude oil, soybeans) all three would come into play. For options on non-dividend paying stocks (e.g. GOOG) only the opportunity cost of capital would come into play.
Consider a put option on GOOG. Assume:
GOOG stock at 1200/share
1-year put option on GOOG with a strike price of 1200/share
1-year interest rate of 5%
The price of a 1-year forward contract would be calculated as:
Forward price = S0 x (1 + r)T = 1200 x (1.05)1 = 1260
Clearly, a 1200 struck put is 60 points out of the money.
If the 1-year interest rate is 10% the put is even further out of the money:
Forward price = 1200 x (1.1)1 = 1320
Under those circumstances the put expiring in 1 year is 120 points out of the money.
The higher the carrying costs the less valuable the put.
How do you expect me to explain something that I wrote 4½ years ago?
I can’t explain something I wrote 4½ _ days _ ago!
OK . . . I’ll give it a try.
Suppose that you own 1,000 oz. of gold and you plan to sell it in 30 days. You have to store it for 30 days and, therefore, pay the storage cost. When you sell it, your profit is reduced by 30 days of storage costs.
Suppose that you don’t own 1,000 oz. of gold, but you plan to sell it in 30 days by writing a 30-day put option on 1,000 oz. of gold. You don’t have to store it for 30 days, so you don’t have to pay the storage cost, and you don’t have to reduce your profit by 30 days of storage costs. Therefore, the put price is reduced by 30 days of storage costs. If it weren’t, there would be an arbitrage opportunity.
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