How RFR affects call values and put values


Can someone explain how an increase in RFR can increase call values and decrease put values?

Thanks alot!

The easiest way to see it is to look at put-call parity:

S0 + P0 = C0 + PV(X)

If the risk-free rate increases, then PV(X) decreases; thus, either C0 must increase or P0 must decrease (or both). If the risk-free rate decreases, PV(X) increases; thus, either C0 must decrease or P0 must increase (or both).

In summary:

  • When RFR increases, call prices increase and put prices decrease
  • When RFR decreases, call prices decrease and put prices increase

I would never bother to memorize the summary; on the exam I’d write out the put-call parity formula and work it out from there.