The Market Price of an Option Is a Function Of

question 24

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 the September 2001 attack on the World Trade Center in New York).

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Definitions:

Myelinated Axons

Axons that are covered by a protective sheath called myelin, which increases the speed at which nerve impulses are conducted.

Nonmyelinated Axons

Axons that lack a myelin sheath, causing them to conduct nerve impulses more slowly than myelinated axons.

Fast Nerve Fibers

Nerve cells that transmit signals rapidly, involved in the processing of information that requires quick responses, such as sharp, immediate pain or motor coordination.

Pain Sensations

The unpleasant sensory and emotional experience associated with actual or potential tissue damage or described in terms of such damage.