GARP.2011.PQ.P1 FRM 2011 Practice exam part 1/exam 2 question 25 (garp11-p1-25)

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The question stated that: "theta is always negative for long calls and long puts and positive for short calls and short puts"

The answer sheet indicated that this statement is correct. However, the review book clearly states ( page 342) that isn't true in some cases for European options.


thank

Tzvi

 

[David Harper CFA FRM]

Tzvi,

Your review book is correct; As Hull says, "Theta is usually negative" ... but it's easy to get a positive theta for a somewhat/deeply ITM Euro put
(for paid members, just lower stock price on BSM_put_theta @ http://www.bionicturtle.com/how-to/spreadsheet/2011.t4.b.6.-option-greeks/)

... intuition: if you hold a deep ITM put, with asset price near zero, more "waiting time" to the Euro expiration is not a good thing, asset price can't go below zero. Volatility has asymmetric effect: mostly works against you to increase asset price/decrease put. You want to expire as soon as possible.

So, this question looks like another error in the sample. Thanks for bringing it up, I will add to list for GARP.

David

 

[monachima505]

One more question of mine from a GARP past exam - the correct answer states that theta is always negative for long put options. But I thought it can be positive for deep in-the-money put options? Am I wrong?

Thanks.

 

[David Harper CFA FRM]

@monachima505 I moved your post as this has already been asked/answered in the forum. This question has a mistake per Hull's two cited exceptions:

Hull Chapter 19, page 410: "Theta is usually negative for an option. [footnote 7] This is because, as time passes with all else remaining the same, the option tends to become less valuable."
[footnote 7:] An exception to this could be an in-the-money European put option on a non-dividend-paying stock or an in-the-money European call option on a currency with a very high interest rate.