Options – Payoff

Practice Question

Intro to Finance
Options
Payoff
MCQs

The value of a put option decreases when:
I. the time to expiration increases.
II. the risk rate of return decreases.
III. the volatility of the underlying asset's price increases.
IV. the underlying asset's price increases.

Select the best answer:

A) Only I and II.
B) Only II and IV.
C) Only III and IV.
D) All statements are correct.
Answer +
Correct Answer: B) Only II and IV.
Explanation +

Let's analyze each statement to determine when the value of a put option decreases:

I. Time to expiration increases:
More time generally increases option value (more time = more chance of ending in the money). So this would increase the value of a put. This statement is incorrect.

II. Risk rate of return (risk-free rate) decreases:
A lower risk-free rate increases the present value of the strike price, decreasing the value of a put. This statement is correct.

III. Volatility increases:
Higher volatility increases the value of both puts and calls. This statement is incorrect.

IV. Underlying asset price increases:
A put becomes less valuable when the asset’s price rises, since the likelihood of exercising the put decreases. This statement is correct.

Conclusion: The value of a put option decreases when:
- The risk-free rate decreases
- The underlying asset's price increases
Correct answer: B) Only II and IV.