Can Someone explain time premium with relation to puts and calls

Discussion in 'Options' started by sevnseat, Apr 25, 2006.

  1. sevnseat


    Ok Topic Says it all:

    I read in an option book that "Puts are usually less affected by time premium than are Calls." But I didn't really get a great explanation... can an options guy explain this one to me?
  2. kny3


    Hey sevnseat.
    Has to do with cost of carry.
    AAPL currently at $67.50.
    Jan '07 65 put at 6.80
    Jan '07 70 call at 9.20

    Both options 2.50 O-T-M, same month, no dividend. Look up "Long Conversion" , they look pretty much in line to me.

    kny 3
  3. 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.
  4. kny3



    kny 3 :cool:
  5. Thanks for the insight. (And, you'll make few points with me trying to impersonate my wife.)
  6. MTE


    That statement doesn't really make sense. The amount of time premium in a call and a put at the same strike is exactly the same when you take into account cost of carry as it has been shown above.
  7. Explain please, how/why a call has a higher cost of carry than a put.....
  8. MTE


    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
  9. I didn't know a call has a cost of carry but a put doesn't. Can you explain why?

    Also... in this example, the call premium is even *greater* than is accounted for by cost of carry.
  10. MTE


    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.
    #10     Apr 26, 2006