Consider two identical European call options on two identical stocks A and B, except that the former stock pays dividends and the latter stock does not. Which of the following statements is most valid?
A) Call A is greater in value than call B.
B) The time value of call A is greater than that of call B.
C) The time value of call B is greater than that of call A.
D) The insurance value of call B is greater than that of call A.

Question

Quizplus · Accepted Answer

The time value of an option reflects the uncertainty surrounding the future stock price. In the case of stock A, the dividend payments reduce the stock price, which reduces the uncertainty about the future stock price, and therefore reduces the time value of the option. Thus, call B has a higher time value than call A.

Consider Two Identical European Call Options on Two Identical Stocks