GENERAL KNOWLEDGE

Detailed explanation-1: -The higher the volatility, the higher the option premium. Higher volatility implies that prices will trade in a greater range over time, which is why the option premium is also higher. Figure 9.21 shows the expected trading range assuming volatilities of 20 and 30 per cent.

Detailed explanation-2: -An increase in the volatility of the stock increases the value of the call options and also of the put option. As can be seen from the above points, it is only volatility that impacts call and put options in the same direction.

Detailed explanation-3: -The value of an option is not, however, a function of past price volatility but of the expected price volatility of the underlying asset over the life of the option. The higher the expected volatility, the larger the expected asset price movements and the greater the value of the option.

Detailed explanation-4: -Sometimes prices move more quickly than at other times. The speed or degree of the price change (in either direction) is called volatility. As volatility increases, the potential to make more money quickly, also increases. The tradeoff is that higher volatility also means higher risk.

Detailed explanation-5: -It can significantly affect the time value portion of an option’s premium. Volatility is a measure of risk (uncertainty), or variability of price of an option’s underlying security. Higher volatility estimates indicate greater expected fluctuations (in either direction) in underlying price levels.