Question

Explain the relationship between the volatility of a stock and the price of the call and put options on that stock (in qualitative terms).  Why is this so?

Answer 1

Volatility is the fluctuations of price of the underlying

Call and put options derive their significance and most of the value due to volatility of the underlying. Volatility directly impacts the values of both options. Higher volatility can mean higher upside or downside risk. When downside is high, put option is more valuable and when upside risk is high then call options are more valuable. This right but not the obligation is what makes them valuable in highly volatile times.

For example, before elections, the stock prices can be highly volatile. During such times if one has a right but the obligation to buy or sell the stock at a future date for a pre determined price then the risk for holder would reduce and as such higher premium would be required for purchasing such options.

Thus, when movement in the market is less, then volatility is low and prices of options would be lower than an opposite scenario.