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Software for Pricing Options
by Kenneth R. Trester
and Robert P. Swanson
Chapter 7 - Other Factors that Influence an Option's Price
Besides the four components of option prices that we mentioned
in Chapter I (the stock price, the strike price, the number of
days until expiration and, most importantly, the price volatility
of the underlying stock), there are other factors that will
influence an option's price.
The most important factor here that will affect a stock
option's price is the dividends paid by the stock. Dividends will
influence the option price because they will have a downward bias
on the stock price when they are paid (ex-dividend day). We have
not included this component in OPTION MASTER® because some
investors do not have this information readily available, and it
takes more time and effort to input this component into OPTION
MASTER®, slowing down the pricing process.
Remember, the mission of OPTION MASTER® is to make it
extremely easy and quick to use, and to be able to price many
options in a short period of time. But dividends are a factor,
and will sometimes influence options prices -- usually to a small
degree. With OPTION MASTER®, it is quite easy to adjust the
pricing model to dividends. To adjust a stock for dividends,
identify what the quarterly dividend payment will be, and if it
is coming up in the near future (within a month or so). Then you
can subtract that dividend from the stock price and enter that
adjusted stock price in OPTION MASTER®.
Dividends will not have too much influence on an option price
unless a large dividend is upcoming, and then, of course, a
slight adjustment in the stock's price will make a correction to
OPTION MASTER®. Small dividends will have little effect on the
option price, and dividends that are two or three months off in
the future may have a small effect on the option price.
Another factor that influences an option's price is the
prevailing interest rate. Interest rates will influence the
market price of an option. When you have high interest rates, of
course, the cost of holding a stock position is more expensive
and an option is a means of holding a stock position without
owning the stock. Therefore, that option in the market will
increase in price, as interest rates increase.
Only price volatility and the factors we previously mentioned
will have an influence in determining whether a stock, index or
futures would be at a certain price in the future. There is some
controversy over option pricers, but we believe OPTION MASTER®
will provide you with a good gauge of what an option's fair value
or true worth should be.
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