Can Someone explain time premium with relation to puts and calls
- Thread starter sevnseat
- Start date
I'm not an option trader, but my logic....
The market has a strong upside bias... there's *almost always* the expectation that the market will go up. Therefore, and with *less* expectation (bias) that the market will go down, the premium for which the put can be sold is less. If the relative value of the put is less than the call, it will degrade more slowly mostly because it cost less to begin with.
No, I didn't mean that the call has higher cost of carry. If you take a call and a put and then compare the time values then you'll see that the call has higher time value. The reason is that the call's premium includes the cost of carry, while the put's premium doesn't.
For example,
AAPL @ 67.85
July 65 call @ 7.10 - time value portion = 4.25 (7.10-(67.85-65))
July 65 put @ 3.50 - time value portion = 3.50
Difference = 0.75.
Cost of carry = 65*0.0475*86/365=0.73.
65 is the strike
0.0475 is the risk-free i/r
86 days to expiry
It is based on the put call parity relationship, aka conversion/reversal.
Long stock+long put=synthetic long call
So, in order for there to be no arbitrage profit the two must have the same price. There's a cost of carry for holding the stock to expiry, that cost must be included in the call's premium otherwise the call would have been underpriced and you could buy the call and short the stock and the put to lock in the profit in the amount of cost of carry (interest).
By the way, the above example was on a stock that doesn't pay a dividend, if the stock pays a dividend then it must be incorporated into the cost of carry. That it, it reduces the cost of carry and thus the call's premium.
The $0.02 difference is not really significant. I took the current fed funds rate as the cost of carry rate, while the priced in rate may be slightly higher.