Certified Management Accountant Practice Exam

When the stock price increases, call options generally gain value while put options tend to decrease in value.

Call options give the holder the right to buy a stock at a predetermined price within a specific timeframe. As the underlying stock's price rises, the potential for profit increases for the holder of the call option, making it more valuable. Investors are more willing to pay a higher premium for the right to purchase the stock at a lower strike price when the stock is performing well.

Conversely, put options grant the holder the right to sell a stock at a predetermined price. When the stock price goes up, the put option becomes less valuable because the likelihood of needing to sell the stock at the strike price (which is now above the market price) diminishes. Therefore, as the stock price rises, the value of put options typically declines.

This relationship between stock price movements and the value of options is crucial for understanding options trading strategies and the mechanics of derivatives in financial markets.