Investments, tenth edition

  If This Variable Increases . . .  

  The Value of a Call Option  

 Stock price,  S  

 Increases 

 Exercise price,  X  

 Decreases 

 Volatility,  s  

 Increases 

 Time to expiration,  T  

 Increases 

 Interest rate,  r  

 f 

  

 Increases 

 Dividend payouts 

 Decreases 

 Table 21.1 

 Determinants of call 

option values 

 Prepare a table like  

Table  21.1  for the deter-

minants of put option values. How should 

American put values respond to increases in 

 S,   X,   s ,  T,   r  

 f 

 , and dividend payouts? 

 CONCEPT CHECK 

21.1 

2

 You should be careful interpreting the relationship between volatility and option value. Neither the focus of this 

analysis on total (as opposed to systematic) volatility nor the conclusion that options buyers seem to like volatil-

ity contradicts modern portfolio theory. In conventional discounted cash flow analysis, we find the discount rate 

appropriate for a  given  distribution of future cash flows. Greater risk implies a higher discount rate and lower 

present value. Here, however, the cash flow from the  option  depends on the volatility of the  stock.   The  option 

value increases not because traders like risk but because the expected cash flow to the option holder increases 

along with the volatility of the underlying asset. 

    21.2 

Restrictions on Option Values  

 Several quantitative models of option pricing have been devised, and we will examine 

some of them later in this chapter. All models, however, rely on simplifying assump-

tions. You might wonder which properties of option values are truly general and which 

depend on the particular simplifications. To start with, we will consider some of the more 

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726 

P A R T   V I

  Options, Futures, and Other Derivatives

important general properties of option prices. Some of these properties have important 

implications for the effect of stock dividends on option values and the possible profitability 

of early exercise of an American option.