InvestorQ : What happens to the price of a put option if the exercise price of the call option contract is moved down lower?
swati Bakhda made post

What happens to the price of a put option if the exercise price of the call option contract is moved down lower?

Answer
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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 put option, the exercise price or the strike price is the price at which you have contracted to sell the particular stock. Let us look at the impact of the above shift upward in exercise price on the value of the put option

Input Data

Input Data

Stock Price now (P)

120

Stock Price now (P)

120

Exercise Price of Option (EX)

125

Exercise Price of Option (EX)

120

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^0.5

0.0866

s*t^0.5

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 Put

6.8345

Value of Put

3.8913

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