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 upward 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)

130.00

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))

129.4595

s*t^.5

0.0866

s*t^.5

0.0866

d1

-0.3800

d1

-0.8328

d2

-0.4666

d2

-0.9194

Delta N(d1) Normal Cumulative Density Function

0.3520

Delta N(d1) Normal Cumulative Density Function

0.2025

Bank Loan N(d2)*PV(EX)

39.8844

Bank Loan N(d2)*PV(EX)

23.1645

Value of Call

2.3542

Value of Call

1.1316

(Note - Period is reduced to yearly decimals

In the above instance we have moved one notch higher on the call option from a 125 strike to a 130 strike. What happens to the value of the call option? There is a sharp fall 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 higher either the positive gap reduces or the negative gap widens. Either way it is negative for the value of the call option. That explains why the value of the call option has fallen in the above case when the exercise price has moved up by one notch.