Question

Suppose that an investor has wrote a six month European call option on Dawn stock, a hypothetical company, with strike price of $40 for a price of $2.what happens to the option price of volatility on Dawns stock decreases?
1.option price will remain unaffected

2.option price will be more than 1.5$

3.option price will be less than 2$

4.none of the above

Answer 1

=> Before moving into the answer we will discuss some of the factors that influence the price of an option

=> I) Stock price : if the price of an underlying asset increases the price of call option increases and price of the put option decreases and if the price of an underlying asset decreases the price of call option decreases and price of the put option increases.

=> 2) Time to expiration : The value of both call and put option decreases as it moves closer to the expiry.

=> 3) Volatility of the stock : The price of both call and put option increases if the volatility of the stock increases and option price decreases if the volatility decreases.

=> 4) Interest rate : if the interest rate increases, the price of call option increases and put option decreases and if the interest rate decreases, the price of call decreases and put increases.

=> 5) Exercise price : Lower the exercise price higher is the call option price and lower is the put option price

=> Now we can move to the answer

=> In this case the volatility on Dawn stock decreases and we have discussed above that if the volatility decreases the call option price also decreases.

* option 1 is not correct as we know that there will a decrease in price, option 2 is not correct because the price of option may or may not be more than $ 1.5 based on the decrease in the volatility , option 3 is correct because as the option price decreases from $ 2, it have to be below $2.

=> Therefore our answer is 3.option price will be less than 2$