The Market Price of an Option Is a Function Of

question 9

Multiple Choice

The market price of an option is a function of:

• A)market expectations regarding the medium term dividend stream expected on the shares underlying the option.Where the exercise price is expected to be greater than the sum of 2 to 3 years' dividends the option will sell at a discount.Where the exercise price is less than 1 year's expected dividend it will sell at a premium.
• B)the difference between the market price of the share and the exercise price on the option.The market price of the option will, however, be greater than this difference where the option does not expire for some time.All other things being equal, the greater the time until the option is to be exercised the greater the difference will be between the price of the option and the difference between the exercise price and the share price.
• C)the liquidity of the shares underlying the options.Investors in the market are more interested in options over shares that are subsequently easily traded.A measure of the liquidity of a share is the average volume of shares turned over during a period.The higher this measure, the higher the market price of the option.
• D)the market price as being closely linked to the exercise price and where it does not vary significantly from that.The only situation in which this ceases to be true is when significant impacts on the whole market shift the prices of many shares down at once (for example, in the case of a major impact to a whole economy such as was experienced in 2007 when the global financial crisis started).

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Definitions:

Reducing Inflation

Measures and policies implemented to decrease the rate at which the general level of prices for goods and services is rising.

Debt-to-Income Ratio

A financial measure that compares an individual's total debt to their total gross income, often used by lenders to assess borrowing risk.

Inflation Rate

The rate at which the general level of prices for goods and services is rising, eroding purchasing power.

Real Growth Rate

The rate at which an economy's gross domestic product (GDP) grows after adjusting for inflation, indicating the actual growth of economic output.