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

What happens to the price of a put option if the exercise price of the put option contract is moved up higher?

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)

130

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^0.5

0.0866

s*t^0.5

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 Put

6.8345

Value of Put

10.5911

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