Chartered Financial Analyst (CFA) Practice Exam Level 2

In the context of option pricing, which of the following factors increases the call option price?

1. Stock Price

2. Exercise Price

3. Time to Expiration

4. Risk-Free Rate

The correct answer is: Stock Price

Increasing the stock price directly influences the intrinsic value of a call option, making it worth more. A call option gives its holder the right to purchase the underlying stock at a predetermined exercise price. When the stock price rises above the exercise price, the call option is considered "in the money," leading to an increase in its price. This relationship is fundamental to the valuation of options: as the stock price increases, the likelihood that the option will end up being exercised increases, which in turn raises its market price. Other factors like the exercise price, time to expiration, and risk-free rate have nuanced impacts on option pricing. For instance, an increase in the exercise price would generally decrease the call option price, as it would require the stock to rise higher to be profitable for the holder. Time to expiration can either increase or decrease the option price depending on other variables, as it influences the time value of the option, while the risk-free rate can have varying effects depending on market conditions and sentiments. However, in the context of this question, the increase in stock price is the clear factor that elevates the call option price.