Time value in put options will, please, understand, one, interest

richer

Could anyone please explain the below:

"If volatility is high & interest rate low, the extra time value will be the dominant factor and the longer term put would be more valuable"


As far as I can understand this:

When volatility goes up, options become more valuable & if interest rates are low, put option would loose value & given that, longer term one holds the option, more are the chances of the holder gaining.

dmar

Just wanted to understand how would volatility & interest as specified above would make the longer term put option more valuable?

invic

@study09

long dated at the money options have high vega (change in volatility w.r.t change in price) and low gamma . also lower interest rates increases put option value and decreases call option value .

to exaclty interpret the quoted sentence I need to know the scenario to which the put option has been compared

sgupta0827

Two things

1. Call and put prices USUALLY increase as volatility increases.

2. According to put call parity:

P = C + X/(1 + RRF) ^T - S

From the PCP equation, if there is an increase in T, the value of the put option will actually fall.

So there are two things to note here. If volatility is relatively high, then a greater time to expiration will allow the put holder more of a chance to benefit (as there is a greater chance of prices being lower than the strike price at expiration).

However, if volatility is relatively low, an increase in the time to expiration COULD result in a DECREASE in the value of a put option. (See PCP equation above).

Think that sorts it out.

Wasteoftime

I seem to have forgotten how to edit a post. So I'll just add to my previous one here.

Just wanted to add that you should check out Elan's samples page. They have their reading and video available for free there.

siavosh

agree with beatthecfa

but I feel volatility depends on other factors like , ITM , ATM , OTM options each have different volatility structure volatility smiles /smirks