Chapter 14, Problem 5Q

To determine

Why greater volatility or longer maturity period provides a higher premium return on both call and put options?

Context Introduction:

Call options:

They provide the owner of the options the right to buy an asset in the future at a mutually agreed upon price. They have a predetermined expiry date as per the contract; the asset can be brought any time before the expiry date or at it. The owner must pay a premium fee to exercise the call which gives the right to buy till the expiry of the option.

Put options:

The owner of a put has the right to sell their underlying assets at pre-decided date and time.

Usually, investors buy a put when they expect the value of the underlying value of the asset to come down, so they have the right but not the obligation to exercise the right. They are good in speculating and give a high return when sold at a short selling period. Price of the contract is determined by the price of the put, profit derived is known as the intrinsic value of the contract, the extrinsic value is the risk taken due to market volatility.