just looking at S2003, Q5(iii). It asks for factors that cause time value of a put to increase. Answer states: "decrease in dividend payments". But, by my calculations lamda for a put has value: which means that as q increases the value of the put increases. Is the examiner wrong or am I mixed up here? Thanks
i'm pretty sure i differentiated it ok, you lose the derivatives of the d1, d2 terms via the formula:
time value Time Value = Option premium (price paid for buying the option) - Intrinsic Value. As dividend payments decrease, the share price will increase (rem: share prices of drop, when dividend payments are made hence if the rate of divident payment decreases share prices will have to increase). This means that intrinsic value decreases. Option premium is a constant. Hence the time value will increase.
I disagree. Time value is the excess of an option's current premium over intrinsic value, not the original premium paid.
Hi Gareth Look at Hull (6th ed), pg 206 , Chp9. The table there shows that if future dividends were to increase the effect would be to increase put's value (american or european) . One can show this via B/S (actually garman Kohlhagen) or via general reasoning, i.e. that share drops at ex-div date and hence payoff of K-ST would be bigger and hence put value should increase. Out of the viepoint of a put holder (who also owns the share) he would receive the increased dividends and hence put should increase in value. I think there are a few errors ("typos") in CT8 papers as well.
Gareth, my answer from my Revision notes states that an increase in expected dividend rate will cause the time value of the put to increase, with no change in intrinsic value. This is very intuitive! The buyer of the put has bought the option to sell an asset at some date in future. (He is said to be long in the put). So he is actually keeping the asset(stock) and will sell it later. This means that an increase in dividend rate will mean that the buyer of the put will recieve a higher dividend than originally expected. He benefits by having the stock at this time and the put option. This means that the put will increase in value. Hope you followed that. Erik. By the way, lambda is positive for a put option, according to my course notes!!!
