Interest Rates | ||
Higher interest rates lead to higher call prices and lower put prices
Interest Rates: It seems counter intuitive that a rise in interest rates would drive up option prices. After all, the buyer of an option has to put up money to purchase the option. This money could otherwise be earning interest. Calls are actually more expensive when interest rates are higher. It is much cheaper to buy a call option than the stock, and the call buyer can invest the remaining capital. Think of term life insurance, buy the option, invest the rest. Put premiums get cheaper as interest rates rise.
Large changes in interest rates are infrequent. When they do change, their effect on option prices is small compared to other factors. The chart above illustrates the impact of a 10 point swing in interest rates. The impact of volatility on pricing is discussed in Chapter 4. |
