Pricing an Option

Factors influencing the price of an option

There are 6 factors that influence the price of an option:

  1. price of the underlying stock,

  2. striking price of the option itself,

  3. time remaining until expiration of the option,

  4. volatility of the underlying stock,

  5. current risk-free interest rate (e.g. 90-days Treasury bills), and

  6. dividend rate of the underlying stock.

The first four items are the major determinants of an option’s price, while the latter two are generally less important. Though dividend rate can be influential in the case of high-yield stock.

In my subsequent newsletters, I will explain the major determinants of price in further detail.