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Consider the following parameters during the pricing of a knock-out put option: So: $50.00 K: $51.00 H: $49.00 σ: 10% Complete the following sentences that apply to changes in the inputs during initial pricing: (Please note that all scenarios below are independent) 1) If So was higher, with other inputs unchanged, the value of the option premium would?? 2) If H was lower, with other inputs unchanged, the value of the option premium would?? 3) If σ was slightly higher, with all other inputs unchanged, the value of the option premium would?? 4) If K was higher, with other inputs unchanged, the value of the option premium would??

Question

Consider the following parameters during the pricing of a knock-out put option: So: 50.00K:50.00 K: 51.00 H: $49.00 σ: 10% Complete the following sentences that apply to changes in the inputs during initial pricing: (Please note that all scenarios below are independent) 1) If So was higher, with other inputs unchanged, the value of the option premium would?? 2) If H was lower, with other inputs unchanged, the value of the option premium would?? 3) If σ was slightly higher, with all other inputs unchanged, the value of the option premium would?? 4) If K was higher, with other inputs unchanged, the value of the option premium would??

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Solution

  1. If So was higher, with other inputs unchanged, the value of the option premium would decrease. This is because a higher underlying asset price makes it less likely that the option will be in the money at expiration, reducing its value.

  2. If H was lower, with other inputs unchanged, the value of the option premium would increase. This is because a lower barrier makes it more likely that the option will be knocked out, reducing its value.

  3. If σ was slightly higher, with all other inputs unchanged, the value of the option premium would increase. This is because higher volatility increases the likelihood of the option being in the money at expiration, increasing its value.

  4. If K was higher, with other inputs unchanged, the value of the option premium would increase. This is because a higher strike price makes it more likely that the option will be in the money at expiration, increasing its value.

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