Peter Black is an options trader for High Smith Investments. Black trades options on the U.S. and U.K. stock exchanges. Over the past three weeks, Black has been following the price movements of options on two companies: U.S.-based Pacific Chemicals Inc. (PCI), and U.K.-based Merchant Clothing Co. (MCC). Black has observed that over the past few days, the price of put options on PCI stock have suddenly increased, and the price of call options on MCC stock have suddenly increased. Which of the following provides the most accurate explanation of Black's observations? Interest rates in:
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A. B. C.C
Based on Peter Black's observations, he has noticed two specific price movements in the options market: the price of put options on U.S.-based Pacific Chemicals Inc. (PCI) stock has suddenly increased, and the price of call options on U.K.-based Merchant Clothing Co. (MCC) stock has also suddenly increased. To explain these observations accurately, we need to consider the factors that influence option prices.
Options are financial derivatives whose values depend on several key factors, including the underlying stock price, the strike price, time to expiration, interest rates, and volatility. Changes in these variables can impact the prices of call and put options differently. Let's analyze the answer choices and their implications:
A. The U.S. interest rates have risen, and the volatility of MCC stock has risen. This answer choice suggests that the increase in put option prices on PCI stock is due to rising interest rates in the U.S., while the increase in call option prices on MCC stock is due to increased volatility of MCC stock. It is important to note that rising interest rates typically lead to a decrease in call option prices and an increase in put option prices. This option does not align with Black's observations, as he noticed both put and call option prices increasing.
B. The U.K. interest rates have fallen, and the volatility of PCI stock has risen. This answer choice implies that the increase in put option prices on PCI stock is due to increased volatility of PCI stock, while the increase in call option prices on MCC stock is attributed to falling interest rates in the U.K. However, the observation does not support this explanation, as Black noticed an increase in put option prices on PCI stock, not call option prices.
C. The U.S. interest rates have fallen, and the volatility of MCC stock has risen. This answer choice states that the increase in put option prices on PCI stock is due to falling interest rates in the U.S., while the increase in call option prices on MCC stock is due to increased volatility of MCC stock. Falling interest rates tend to increase call option prices and decrease put option prices. Additionally, increased stock volatility generally leads to higher call option prices. This answer aligns with Black's observations, as he noticed an increase in put option prices on PCI stock (likely due to falling interest rates) and an increase in call option prices on MCC stock (likely due to increased volatility).
Therefore, the most accurate explanation of Black's observations is option C: the U.S. interest rates have fallen, and the volatility of MCC stock has risen.