Question

what should the effect of increasing interest rates be on the price of a 3-month European-style put option? What about for a 3-month European-style call option? Why?

Answer 1

Increasing interest rates will decrease the price of a put option and increase the price of a call option. This is because of the delay in cash flows associated with options. In a call, we pay to buy the underlying at a future point of time, and an increased interest rate will increase it's value in the present. Hence, the call price will increase. Similarly, for a put option, we are paid to sell the underlying and since we are getting the payment late in a higher interest rate environment, the put price is less.