What Role Does the Risk-Free Rate Play in Options Pricing Models like Black-Scholes for Long-Dated Contracts?
The risk-free rate is used to discount the expected future payoff of the option back to its present value. For long-dated contracts, this discounting effect is more pronounced.
A higher risk-free rate generally increases the theoretical price of a call option and decreases the theoretical price of a put option, reflecting the time value of money.
Glossar
Risk-Free Rate
Rate ⎊ The risk-free rate represents the theoretical return on an investment with zero risk, serving as a critical input in option pricing models to calculate the cost of carrying an asset forward in time, particularly relevant for valuing longer-dated crypto options.
Higher Risk-Free Rate
Volatility Premium ⎊ ⎊ A higher risk-free rate directly impacts the volatility premium demanded by option sellers, increasing the cost of hedging and consequently, the price of options across all strike prices.
Pricing Models
Valuation Method ⎊ Pricing Models are the mathematical frameworks used to estimate the fair value of an option contract by projecting the probability distribution of the underlying crypto asset's future price.
The Black-Scholes Model
Foundation ⎊ The Black-Scholes model serves as the cornerstone for modern options pricing theory, providing a continuous-time framework for calculating the fair value of derivatives.