I know that the risk free rate effects option pricing according to the black and scholes model but if inflation is 4.5% for this year then will the option premiums increase by the inflation rate keeping other variables constant?
Change in Inflation then there might change in Interest rates from RBI MPC with other factors considered. The factor of inflation is indirectly include through interest rates hikes or reductions. That’s my understanding.
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A little far fetched. In the sense economics does not affect interest rates immediately. Also liquidity is something which affects the short end of the interest rate curve. So even if interest rates are low, the liquidity can cause short term high rates - Mibor in this case. So although you are largely on the right track this need not happen
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In pure economical terms, it will have indirect impact on option pricing. If you have inflation, means that it will probably be regulated through Central Bank interest rates. As you know, CB rates are affecting risk-free rates, so, there is your connection
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Ya, just like prices of everything else go up as much as the inflation rate even the premium to buy a call/put will go up… got it