Consider a one-year, at-the-money call option on Taggart stock. The effect on the price of this call option of an increase in the volatility from 25% to 40% is closest to:
A) $0.70 increase
B) $1.70 decrease
C) $2.30 increase
D) $2.80 increase

Question

Quizplus · Accepted Answer

The price of a call option is positively related to the volatility of the underlying stock. Therefore, an increase in the volatility from 25% to 40% will increase the price of the call option. The exact increase can be calculated using the Black-Scholes model or a similar pricing model. Without using a model, we can estimate based on the option's delta, which is typically between 0 and 1 for at-the-money options. Assuming a delta of 0.5, a 15% increase in volatility would lead to a 7.5% increase in the value of the option. If the option is priced at $3, for example, a 7.5% increase would be $0.225, which rounds to $0.23 or $2.30. Therefore, the closest answer is C) $2.30 increase.

Consider a One-Year, At-The-Money Call Option on Taggart Stock