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Option Value and Interest Rate

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(Querist)
20 April 2008 Please explain how interest rate effects the value of option?
How does option value increase with rising interest rate?
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Sorimuthu

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Sorimuthu (Expert)
23 September 2009 Value of an opiton is nothing but an interest you would pay for the contract amount. hence if the interest rate raises then the value of the option will also raise.
To put in numbers, say you want to buy nifty 5000 option when the nifty is trading at 5000. Assume i have an option to rasie bank loan at 5%. If I buy the contract for 5000 and pay interest Rs.25 for that i would price the option which is more than Rs.25.

Practically, interest rate is not a only factor that determines the option price, there are other factors like volatality and liquidity.
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