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Factors That Impact Option Prices – Option Trading

Hi my name is patrick boyle and welcome to my youtube channel so in today’s video we’re going to talk about factors that impact the price of option so there’s a bunch of things that we need to talk about probably the most obvious one is the the price of the underlying and i think when you first learn about options it seems like almost the only thing that’s

Gonna affect the value of an option is the price of the underlying so with a call option if you’re long a call option if the price of the underlying moves out that would increase the value of the call option and if you’re a long a put option and the price of the underlying falls that would increase the value of the of the put option and while that’s correct

There are six different factors that we’ll talk about the first one we’ve already really spoken up which was the current stock price and the the second one is the strike price that’s agreed upon and obviously this because the payoff of a stock option relates to the difference between the strike price and the stock price at expiration the strike price will have

A similarly like as obvious effect on the payoff of an option the next one we’ll talk about is time to maturity or how much time is left on the option and the more time that’s left on an option the more valuable it will be and that seems maybe a little bit obvious but maybe not as obvious and neat as it needs to be so let’s talk a little bit about extreme okay

So let’s imagine you have a call option and the underlying is trading at 100 and the strike price of the option is 200 so in order for that option to become exercisable in the price of the underlying needs to double now that option if i told you that that option expires in two minutes time you might think that that that option is close to valueless because

It may be extremely unlikely for the underlying to double in the next two minutes now if i told you that that option expired in 30 years time you would probably see that that option is quite valuable and i i guess the reason for giving that example is to point out how how much it matters how much time there is left to expiry on an option and how that will

Affect the value now that will affect both the value of call options and put options because essentially the more time that there is remaining the more things that can happen either to drive the price up and off the lot or to drive the price down an awful lot so for either type of option the longer the time to expiration the more an option will be worth and so

Then equally when we look at an option and and call option with 30 days to expire will be worth a little bit more than a call option with 29 days to expire all other things equal cidades time to maturity the next thing that we’ll talk about is the volatility of the underlying in finance we often talk about volatility volatility we usually measure with standard

Deviation and the more volatile the underlying is the the more an option is worth and that works for both puts and calls on the same underlying now that at first may not make intuitive sense but let’s think a little bit about it if we have two underlines if there’s one company it’s a water utility company and the stock price doesn’t do much because it’s in kind

Of a boring industry you know our water utility they can’t hike up the price of water in order to increase their profits and they’re not really gonna see huge swings in in demand or supply really so that might be a very staid business on the other hand we might have quite a volatile business like we’ll say for example biotech company and so a biotech company

Might be bringing a new product a new medicine to the market that is being trialed right now should the trial go well they might have a huge market for this product and should i’ll go badly the company might be you know financially in trouble and so when you have an option on either of these two companies all other things being equal the option on the biotech

Company what a call or put option will be much more valuable than the call are put option on the on the water utility and so the reason for that is just quite simply that the the biotech company it’s in a much more volatile business and so it’s more likely for that that stock price to double but it’s equally more likely that it will have you know either thing

Can happen and that is taken into account in the volatility and so as we go on we’ll have probably a few other videos on the topic of volatility because it’s one of the most important things in pricing options but you’ll start to see how important volatility is when we’re pricing options so the next thing up is the risk-free interest rate and because you know

We haven’t yet gotten to our formulas for pricing options but as you can imagine every formula in finance and the present value in the future cash flow that will be in the formulas that we use to to price our options and so the changes in the risk-free rate will impact the price of options and i’ll do a video on that a little bit later but that that tends not

To have a huge impact like compared to some of the other things we’ve just spoken about the risk-free rate won’t have a huge impact and then finally dividends expected over the life of the option dividends will impact the the price of options and the reason for that is that they will impact the returns of the underlines so whenever company pays a dividend under

Normal circumstances you would expect the price of the stock to fall by the amount of the dividend paid and obviously therefore a dividend being do one on a under will will decrease the value of a call option on that underlying and increase the value of a put option on that underline once again we’ll we’ll talk about these things in greater detail when we get

To doing a video on the greeks which we’ll do in a few weeks anyhow i hope you found this video useful if you did make sure you hit the like button subscribe if you’d like to see more videos like this and comment below if if there’s any videos you’d like me to make have a great day bye

Transcribed from video

Factors That Impact Option Prices By Patrick Boyle