General Securities Representative (Series 7) Practice Exam

What is the most important factor when determining the premium for an option?

1. Interest rates

2. Market value of the stock

3. Expiration date

4. Underlying asset volatility

The correct answer is: Market value of the stock

The most crucial factor when determining the premium for an option is the market value of the stock. This is because the intrinsic value of an option is derived from how close the underlying stock's market price is to the strike price of the option. For call options, if the market price of the stock rises above the strike price, the option becomes more valuable, which increases the premium. Conversely, for put options, if the market price falls below the strike price, the premium also increases. The current market value is therefore essential in calculating the option's value, as it reflects the immediate profitability of exercising the option. While other factors such as interest rates, the expiration date, and underlying asset volatility do play roles in pricing options, they do so in conjunction with the market price but are not as foundational as the direct relationship between the underlying asset and the option's strike price. Interest rates can affect the cost of carrying the option, the expiration date affects the time value, and volatility impacts the expected price movement of the stock; however, these factors ultimately revolve around the market value of the stock, making it the most influential in determining an option's premium.