Strike price.

If the strike price of a call option is low, then one has to pay a higher premium.

For example, if the value of INFY call with a strike price of Rs.1000 is Rs.20, then INFY having a strike price of Rs.960 would be higher than Rs.20, say Rs.24. The logic is simple. A lower strike price would mean that the holder has the right to buy the share for a lesser price. As this gives the call option with a lower strike price more value, the premium will also be high.

In the same way, a put option having a higher strike price will attract a higher premium. It is because the buyer of the put option has the right to sell the shares at a higher price.

In the case of Calls: A lower strike means a higher premium.

In the case of Puts: A higher strike means a higher premium.

The spot price of the underlying stock.

We had seen in a previous lesson on moneyness of option that it could be in-the-money or at-the-money or out-of-the-money depending on how the price of an underlying stock has moved. If the cost of the underlying stock is at a very high level, then the value of the call option that is in-the-money will be higher. In the same way, if the price of the underlying stock is low level, then the value of the put option that is in-the-money will be higher.

Therefore, the spot price of the share is a crucial factor affecting the option price.

In the case of Calls: A higher spot means a higher premium.

In the case of Puts: A higher spot means a lower premium.

Time to expiry

When the time remaining for an option to expire is more, the possibility of the option moving in-the-money is also more. It means that more the time to expiry of the option contract, the higher will be the premium to be paid. So, one has to pay a higher premium for an option having a three-month expiry when compared to an option contract with one-month expiry.

In the case of Calls: More time to expire means a higher premium.

In the case of Puts: More time to expire means a higher premium.

The volatility of the underlying stock

We have just seen that the strike price, spot price, and the time to expiry of the option have considerable influence on its price. In addition to this, if the stock price is volatile, then the chances for an option contract to reach desired levels are high. So, the option holder is in a better position because volatility in the price of a stock only increases the chances of the option holder to make maximum profit. Even if they don’t make a profit, they stand to lose only the premium paid.

Options writers, on the other hand, have to face greater risk and so they have to be compensated accordingly.

In the case of Calls: Higher volatility of the stock price means a higher premium.

In the case of Puts: Higher volatility of the stock price means a higher premium.

Risk-free rate

When there is an increase in the risk-free interest rate, the current value of the strike price decreases and this increases option price.

So, in the case of a call option, one is postponing the expense of purchasing the shares. In the case of the put option, one is delaying the income receipt.

In the case of Calls: A higher rate of interest means a higher premium.

In the case of Puts: A higher rate of interest means a lower premium.

Dividends

The price of a share reduces to the extent of dividends declared, and in turn, increases the value of the put option and reduces a call option.

In the case of Calls: A higher dividend means a lower premium.

In the case of Puts: A higher dividend means a higher premium.

Any of the above factors can influence the pricing of the options, and the option traders use the above models to value the options contracts before expiry.