Question

For each event, describe what you think would happen to the premium for both an at-the-money call option and an at-the-money put option on a stock.

a.The stock’s price rapidly jumps 10%.

b.A week passes with very little change to the stock’s price.

c.The spread of COVID-19 creates high volatility for the stock (though on average the price is largely in line with the pre-COVID trend).

d.The firm issues an earnings report which has no impact on the spot price (i.e. in line with expectations).

Answer 1

a.The stock’s price rapidly jumps 10%.

At-the-money call option increases while at-the-money put option decreases. This is the effect of delta.

b.A week passes with very little change to the stock’s price.

The premium of both the call and put option decreases because of theta decay.

c.The spread of COVID-19 creates high volatility for the stock (though on average the price is largely in line with the pre-COVID trend).

The premium of both the call and put option increases because of the increase in volatility in the underlying stock.

d.The firm issues an earnings report which has no impact on the spot price (i.e. in line with expectations).

The volatility of the stock goes down significantly resulting in fall in premium of both the call and put options.