What drives an option's price?
The six inputs and the direction of each effect.
Answer it out loud firstTake 30–60 seconds, as you would in the room. Then compare with the model answer.
Show the model answer
The price of the underlying, the strike, the time to expiry, volatility, interest rates and dividends. Volatility is the one that matters most and can't be observed directly — more volatility makes both calls and puts more valuable, because the holder benefits from large moves but can only lose the premium. More time usually adds value too.
The full answer
| Increase in | Call | Put | Why |
|---|---|---|---|
| Underlying price | Up | Down | Closer to or further from the money |
| Strike | Down | Up | |
| Volatility | Up | Up | More chance of a large favourable move |
| Time to expiry | Up | Up (usually) | More time for moves |
| Interest rate | Up | Down | Paying the strike later is worth more |
| Dividends | Down | Up | The share price drops on the ex-date |
Black–Scholes
The standard model prices European options from these inputs; the volatility that makes the model match the market price is the implied volatility — how options are actually quoted.
Mistakes to avoid
Saying higher interest rates lower call values (they raise them).
Follow-ups they may ask
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