Option Pricing Model as Risk free interest rate

We are going to talk about the risk free interest rates. These are actually theoretical interest rate that would be returned back on a venture totally free of risk, usually taken to be the acquiesce on some months funds Bills.

At first quick look it is a bit stiff to visualize why this would have an effect on option prices. Though, it is in the assumption that other side of the trade may be holding the stock for no probable return and that stockholder owes a risk free return for having their capital fixed up and not to going earn interest.

The information, that you are paying the risk free interest rate up front resources that the longer to option finish, the higher the interest rate constituent of the call option premium. Of course it also means that better-quality risk free interest rates mean superior call option prices, all things being equal.

With put options the tale is somewhat strange. It is not the option writer who is supposed to be holding stock, as is with the case with call options; it is the option holder who is supposed to be holding the stock. The holder of a put option has the right to sell the original to the writer, so it is the put option holder who is remunerated for loss of interest income on cash before putting to the option writer.

It should be noted that the where there is genuine cost of hold considerations, that is when the stockholder is essential to finance the stock holding with ready money and/or interest paid on margin. With options on futures, the cost of carry is prices into the price of the futures contract; therefore risk free rates have no important effect on option prices.