Explanation

When using a single implied volatility (GBP 30) for valuation across different strike prices, the volatility smile effect is ignored. The volatility smile typically shows that:

• Out-of-the-money (OTM) options have higher implied volatilities than at-the-money options
• In-the-money (ITM) options have lower implied volatilities than at-the-money options

Using a single volatility of GBP 30 (which is likely the at-the-money volatility) will:

• Undervalue OTM options because their actual implied volatilities are higher than GBP 30
• Overvalue ITM options because their actual implied volatilities are lower than GBP 30

Therefore, an out-of-the-money call (Option A) will be undervalued when using the GBP 30 implied volatility, as the market typically prices OTM options with higher implied volatility due to the volatility smile effect.

Key Points:

• Volatility smile causes different implied volatilities for different strike prices
• OTM options have higher implied volatility than ATM options
• Using a single ATM volatility undervalues OTM options
• ITM options would be overvalued in this scenario