InvestorQ : What happens to the price of a call option if the exercise price of the call option contract is moved down lower? # What happens to the price of a call option if the exercise price of the call option contract is moved down lower? Answer 1 year ago

The exercise price or the strike price is the price at which you contract to buy or sell the asset. In case of a call option, the exercise price or the strike price is the price at which you have contracted to buy the particular stock. Let us look at the impact of the above shift downward in exercise price on the value of the call option.

 Input Data Input Data Stock Price now (P) 120.00 Stock Price now (P) 120.00 Exercise Price of Option (EX) 125.00 Exercise Price of Option (EX) 120.00 Number of periods to Exercise in years (t) 0.08333 Number of periods to Exercise in years (t) 0.08333 Compounded Risk-Free Interest Rate (rf) 5.00% Compounded Risk-Free Interest Rate (rf) 5.00% Standard Deviation (annualized s) 30.00% Standard Deviation (annualized s) 30.00% Output Data Output Data Present Value of Exercise Price (PV(EX)) 124.4803 Present Value of Exercise Price (PV(EX)) 119.5010 s*t^.5 0.0866 s*t^.5 0.0866 d1 -0.3800 d1 0.0914 d2 -0.4666 d2 0.0048 Delta N(d1) Normal Cumulative Density Function 0.3520 Delta N(d1) Normal Cumulative Density Function 0.5364 Bank Loan N(d2)*PV(EX) 39.8844 Bank Loan N(d2)*PV(EX) 59.9799 Value of Call 2.3542 Value of Call 4.3903 (Note - Period is reduced to yearly decimals

In the above instance we have moved one notch lower on the call option from a 125 strike to a 120 strike. What happens to the value of the call option? There is a sharp increase in the value of the call option. Why is that so? A call option value is based on the positive gap between the stock price and the exercise price. When the exercise price or strike price is moved one notch lower, either the positive gap increases or the negative gap reduces. Either way it is positive for the value of the call option. That explains why the value of the call option has risen in the above case when the exercise price has moved down by one notch.

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