Question

1. a) Explain and discuss the parameters that influence the price of European-style options and the nature of their impact.

b) Discuss ways in which a put or a call option may be used in hedging and speculation.

                                                                                                                                   

Answer 1

1.a. European style options are those options which can only be exercised at the maturity period as it cannot be exercise before the date of the maturity.

There are various parameter that influence the price of European style options.-

I. Strike price-it is the price of which options is to be purchased and if the current market value is higher or lower than the strike price the options become exercisable.

II. Current market price-it refers to the current market value of a stock and it is to be compared with the the strike price and if the current market value is lower and higher than the strike price option is to be exercised.

III. Volatility-volatility generally increase the price of options as it gives traders hope that there would be higher fluctuations in the price so they could exercise option.

IV. Time to expiration- Time to expiration will provide higher time window in order to exercise an option, if there is more time available before the maturity of the option.

V. There are other factors like interest rates and inflation which are also impacting the price of the European option but to a very minimum extent.

1. B. Put options or Call option can be used as a tool for hedging & speculation as they provide the right to the option holder either to buy a specific number of share or other to sell a specific number of share before the maturity

One can hedge through call option , when a trader is short on some stock, and he will buy the call option in order to hedge himself from upside moment in the share to reduce is losses.

investors who holds the long-term portfolio, generally buy a put option in order to hedge themselves from the downside risk as when the market will go down, the value of the put option will increase, and it will minimise the overall loss.