InvestorQ : Can you explain why the interest rates in the market impact the value of the call and put option?
shrinidhi Rajan made post

Can you explain why the interest rates in the market impact the value of the call and put option?

Answer
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1 year ago


That is certainly an interesting question. Let us understand the importance of interest rates in this entire option valuation. There are two prices that you typically consider in option valuation viz. the strike price and the market price. The strike price is the price at which you contract to buy or sell the option and is also called the exercise price. The strike price remains the constant and it is only the market price that keeps changing. However, there is a dichotomy here. Let us understand this dichotomy.

The strike price pertains to the expiry date. For example, when you buy a Reliance 1200 March Call option it is the right to buy Reliance at Rs.1200 on the last Thursday of March. But the market price pertains to the current date. Hence to make them comparable, you need to calculate the present value of the excise price or the strike price. This present value discounting is done based on the interest rates and that is why interest rates are relevant to the calculation of the option value. This applies to call options and to put options.