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CFA Level I · CFA Level I Exam · Pricing and Valuation of Options

Holding all other BSM inputs constant, an increase in the volatility of the underlying asset will most likely cause the values of a European call and a European put on the asset to:

Both the call and the put increase in value. Higher volatility raises the chance of large favorable price moves while the holder's loss is capped at the premium paid, so vega is positive for both long calls and long puts.

  1. ABoth values increaseCorrect
  2. BCall value rises and put value falls
  3. CCall value rises while put value stays the same

Explanation

Vega is positive for both calls and puts. Higher volatility widens the distribution of terminal prices, and since the downside of a long option is limited to the premium, both options gain value.

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