Interview Question: When the Bad News Hits

Sample Question #103 (finance – option pricing)

Let’s say that IBM just announced a catastrophic drop in its quarterly earnings and lowered its full-year earnings guidance. How will its option prices react to this news?

(Comment: this is a case-type question)

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4 Responses to Interview Question: When the Bad News Hits

  1. Brett says:

    ANSWER
     
    Obviously the underlying stock’s price will drop like crazy, so that affects call prices negatively and put prices positively.
     
    Also, we can expect IBM stock’s volatility to increase.  Do you know how this affects the option prices? 

  2. Zhe says:

    both will increase.

  3. Wu Chao says:

    In practice, for the deep out of the money option (such as call), it will not affect its value since nobody will be interested in it.Most affected options are those at the money option and those nearby.

  4. Brett says:

    That’s usually true, but what if IBM’s stock drops so much that an originally deep out-of-the-money call has a chance of becoming at the money? Options are just fascinating and frustrating, aren’t they? 

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