Pricing Stock Options
Much of what was discussed about index options also applies to stock options. The factors that affect option prices are listed below.
The Stock Price
The payoff from a call option will be the amount by which the stock prices exceeds the strike price. Call option, therefore, becomes more valuable as the stock price increases and less valuable as the stock prices decreases. Put options, therefore, becomes more valuable as the stock price decreases and less valuable as the stock price increases.
Application of Black-Scholes Option Pricing Formula to Stock Options
The Black-Scholes options pricing formula, with some adjustment, can be used to price American calls and puts options on stocks. Therefore, owning an option on a dividend paying stock today is like owning two options: one being a long maturity option with a time to maturity from the starting date till the expiration day, and the other being a short maturity option from the starting date till just before the stock goes ex dividends.