Time to Expiration/Maturity Homework Help

Time to Expiration/Maturity

It is very evident from the right part of Equation 5.10, that the higher is the value of t, the lower will be the present value of exercise price (to be paid in future year 0. Since this amount is to be subtracted from S to determine C it obviously implies the higher value of call option assuming other, things remain constant. In Example 5.5, let us assume time to expiration of 2 years instead of one year. The value of call option enhances to Rs 11.51 (i.e, Rs 125 - Rs 113.49, PV of Rs 130 x 0.873, PV factor for two years at 7 per cent rate of discount).

The above four factors are the only relevant factors affecting the value of call option when an option is certain to finish in the money. However, in practice, the option may finish out of the money also. In the latter situation, the fifth factor, related to price volatility of share becomes relevant.

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OPTION VALUATION

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