Chartered Financial Analyst (CFA) Practice Exam Level 2

Which of the following statements is true about the relationship of exercise price and put options?

1. Higher exercise price increases call value

2. Lower exercise price increases put value

3. Higher exercise price decreases put value

4. Exercise price does not affect option prices

The correct answer is: Higher exercise price decreases put value

In the context of put options, the relationship between the exercise price (also known as the strike price) and the value of the option is crucial for understanding how these financial instruments function. A higher exercise price generally decreases the value of a put option. This is because a put option gives the holder the right to sell an asset at the exercise price. As the exercise price increases, the likelihood that the option will be exercised at a profitable level diminishes, particularly if the market price of the underlying asset rises or remains high. Hence, a higher exercise price reduces the intrinsic value of a put option when the market price is below the strike price, making the option less valuable overall. The incorrect options either misrepresent the effects of exercise prices on the valuation of options or state general principles that do not apply specifically to put options. Understanding this relationship is vital for option pricing theories and practical investment strategies.