Which of the following most accurately describes the sensitivity of the call option value to changes the underlying asset’s volatility? The sensitivity to changes in the volatility of the underlying is the greatest when the call option is: A) at the money. B) in the money. C) out of the money. D) it depends on the other inputs
C
a
According to Schweser answer A is correct. I thought the answer was B, in the money, because a far in the money call option has a delta that approaches 1, suggesting that the option trades almost exactly the same as the underlying. Any volatility increase in the underlying would have the same effect on the option, would it not? Could you please explain nikko?
the question is asking about the sensitivity of the call option to underlying… this is gamma.
True, the answer suggests the question is asking about gamma. I’m just not convinced the wording is asking for how sensitive the options delta is to the vol of the underlying. Thanks for the help though.
jblazarus Wrote: ------------------------------------------------------- > According to Schweser answer A is correct. > > I thought the answer was B, in the money, because > a far in the money call option has a delta that > approaches 1, suggesting that the option trades > almost exactly the same as the underlying. Any > volatility increase in the underlying would have > the same effect on the option, would it not? Could > you please explain nikko? Actually a vol change in the underlier would have no effect on the option for a far out of the money option. Realized vol might have an effect on the option, but you should think of vol as an expectation of change. For example, suppose that MSFT announces that they will release a new operating system in June. It could be great. It could be a disaster. But one way or another the stock is going to move in June. The option vol for options expiring after the release date goes up. That means options become more expensive. The reason vega is highest for ATM options is that in some sense an ATM is the uber-option. A far out of the money option’s value doesn’t get affected by anything very much because the probability is really high it will turn out to be nothing. (fix that sentence for ITM options). An ATM option is in between those extremes and is most affected by vol. BTW the curve of vega vs stock price is a multiple of a normal pdf with mean = strike.
nikko0355 Wrote: ------------------------------------------------------- > the question is asking about the sensitivity of > the call option to underlying… this is gamma. Nope
Could call Joey. I just found the vega/strike price graph in a John Hull book.
The Sensitivity of the call option value to changes in the underlying asset’s volatility is VEGA (Option Greek) and the answer to this question is ‘A’. Think of that belly-up graph at Strike price X
I don’t believe the graph is in the CFA or Schweser text
it was early and I was thinking of the vol skew when answering the question, but yes, now that I think about it again, the sensitivity to vol is highest for ATM and drops off for both ITM and OTM