Option's pricing - anomaly?

CFA Level II
#1

Hello everyone :slight_smile:

I have a question with regard to the option pricing - not really a CFA I level topic but I hope someone will help me to understand the issue.

Lets assume situation below (which has actually happened in the past):

Current spot exchange-rate for TRY/EUR = 6.8. Below we have following put options and its prices:

  • 1-day PUT 8.80 (premium of 2.00 TRY for every EUR)

  • 1-month PUT 8.80 (premium of 1.87 TRY for each EUR)

  • 12-month PUT 8.80 (premium 0.80 TRY for every EUR)

My questions is - what might be the reason that options with a longer expiration date are cheaper than those of shorter maturity? (interest rates? economic forecast or macro situation?) I know it’s not a common phenomenon but it seems that it happens.

You are welcome to join the discussion :slight_smile:

Thanks,

Michael

#2

Hi Michael,

Premium is declining since market participants are perceiving lower value for puts with longer maturities and pricing them accordingly. Meaning market participants are also expecting the underlying (TRY/EUR) to go up in value. The deeper explanation is market expects above underlying price behavior because the term structure of interest of price currency (TRY) relative to (EUR) is higher. In other words interest rates for TRY is higher than for EUR. Hence TRY should depreciate with respect to the EUR and TRY/EUR should go up.

Hope this clarifies!

Best Regards,

Raveen