Understanding Implied Volatility Impact on Option Pricing

Hard Option Valuation Implied Volatility

John is a portfolio manager who is analyzing a particular call option on XYZ Corporation's stock. The option has a strike price of $50 and expires in three months. John notices that the market price of the option is significantly higher than what he would expect based on historical volatility. He suspects that the market has priced in an increase in the stock's volatility. Using the Black-Scholes model, he calculates the implied volatility of the option, which comes out to be 30%.

Further research indicates that the average historical volatility of XYZ's stock over the last year has been around 20%. Given this information, answer the following question regarding the implications of implied volatility in option pricing.

The high implied volatility compared to historical volatility suggests that traders expect significant price movement, leading to a potential increase in the option's price.

The implied volatility being lower than historical volatility indicates that the current market sentiment is pessimistic about future price movements.

Implied volatility is independent of the underlying asset’s historical volatility and does not affect the option's price.

Hint

Submitted6.8K

Correct6.0K

% Correct88%