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NISM Certifications · NISM-Series-VIII: Equity Derivatives · Introduction to Options

Which statement about the relationship between a European call option's premium and volatility of the underlying, other things equal, is correct?

Higher volatility of the underlying increases a call option's premium. Greater volatility raises the chance of a large favourable move, while the buyer's loss stays capped at the premium paid. This affects both calls and puts through time value rather than intrinsic value.

  1. AHigher volatility increases the call premiumCorrect
  2. BHigher volatility decreases the call premium
  3. CVolatility affects only put premiums
  4. DVolatility affects only the intrinsic value of the call

Explanation

Greater volatility raises the chance of large favourable price moves while the buyer's loss remains limited to the premium. Hence option values, calls and puts, rise with volatility. This works through time value, not intrinsic value.

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