What does Rho measure in option pricing?

• A. Sensitivity to changes in the stock price
• B. Sensitivity to changes in the risk-free interest rate
• C. Sensitivity to changes in dividend yields
• D. Sensitivity to changes in volatility

Answer: (B)

Rho specifically measures the sensitivity of an option's price to changes in the risk-free interest rate. In the context of options, as interest rates change, the present value of the exercise price and any cash flows associated with the option will also change. For call options, higher interest rates typically increase the option's price because the present value of the exercise price decreases, making the option more attractive. Conversely, for put options, an increase in interest rates generally reduces the option's price for similar reasons.

Understanding Rho is crucial for options traders and investors, as it helps them assess how fluctuations in interest rates impact the value of their options positions. This sensitivity is vital in broader financial strategies and risk management.