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What are Options?

  • Options are contracts that give its buyer the right to buy or sell a particular asset
    • In future
    • At a pre-decided price (i.e. exercise or strike price)
    • Without any obligations
  • The seller of the option collects a payment (Premium) from the buyer for providing the option
    • Types of options:
      • Call or Put Options
      • Call Option: Gives option holder the right to buy the asset at an agreed price
      • Put Options: Gives option holder the right to sell the asset at an agreed price
      •  European or American Options
      • European options: Are those that can only be exercised on expiration
      • American options: May be exercised on any trading day on or before expiration


Early exercise of an option is more likely for:
European calls options on stocks paying large dividends.
American call options on stocks paying small dividends.
American put options deep in the money and close to maturity.
American put options on stocks paying large dividends.


European options cannot be exercised early
Small dividends will not make much of a difference in the price fall in the stock
A deep in the money put option should always be exercised early because it is likely that the stock might recover from the fall
Though this might be profitable if the stock prices significantly fall after the ex-dividend date but the third option is likely to provide more profit



Assuming the stock price and all other variables remain the same what will be the impact of an increase in the risk-free interest rate on the price of an American put option?

  1. No impact
  2. Negative
  3. Positive
  4. Cannot be determined

B. (Negative)


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