Six out of the seven factors used in valuing options are known, and the last – Volatility – is supposed to be an estimate.
Since volatility holds a lot of weight in valuing an option, and we always have to use an “estimate” it makes it impossible to calculate the true value of any option.
This is because the call option is now much closer to being ITM at $49 than it was if it was trading at $40. Thus an option on a volatile stock is much more expensive than one on a less volatile stock.
We all know that consumer demand, seasonal changes, crude oil prices, refinery productivity, state and local taxes, etc all affect the price you pay at the pump. As any other finance professional will tell you, calculating this by hand back at the universities is painful and tedious but does help you understand what can affect option pricing.
More specifically, it’s the future volatility used in the model which makes it very hard price the option. Strike Price – This is the price at which a call owner may purchase stock, and the put owner may sell stock.
Dividends – If a stock trades without giving the stockholder any dividend, it is said to be ex-dividend and its price goes down by the dividend amount.
Remember that even a small change in the volatility estimate can have a big impact on an options price. Clearly there would be a difference depending on which side of the trade and market you are on.
If a trader decides to buy a call option instead of stock, then the extra cash they have should theoretically earn interest for them.
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