Practice Question
An increase in which of the following will increase the value of a call option?
I. Dividend payments of the underlying asset
II. Interest rates
III. Variance of the return on the underlying asset
IV. Time to expiration
A) II and IV only
B) II, III, and IV only
C) I, III, and IV only
D) II and III only
E) I, II, III, and IV
Interest Rates (II): Higher interest rates raise call option values because the present value of the strike price is lower.
Variance (III): More volatility increases the potential for large upward moves, boosting the value of calls.
Time to Expiration (IV): More time allows more opportunity for the stock price to rise above the strike price, increasing call value.
Dividend Payments (I): Higher expected dividends reduce call value, since the underlying asset drops in price when dividends are paid.
Conclusion: The correct answer is B) II, III, and IV only.