Explanation:
The increase in volatility will increase the prices of both call and put index options. The reason for this is that higher volatility increases the potential for large movements in the underlying index, which benefits both call holders (who benefit from upward movements) and put holders (who benefit from downward movements). This wider distribution of potential outcomes raises the expected payoff of both types of options, thereby increasing their prices. Volatility is a key input in options pricing models (such as Black-Scholes), and it has a positive effect on the value of all options, regardless of whether they are calls or puts.
Choice A is incorrect. Higher volatility increases the value of both calls and puts, not just calls.
Choice B is incorrect. While higher volatility does increase put prices, it also increases call prices, not decreases them.
Choice C is incorrect. Higher volatility actually increases option prices, not decreases them, due to the greater potential for favorable price movements in the underlying asset.
Q.747 Jack Anderson, a portfolio manager at Vito Investment Company, manages an $800 million mutual fund that invests in a large variety of financial instruments. A significant portion of the portfolio is invested in call and put options on the S&P 500 index (SPX), NASDAQ-100 Index (NDX), and Dow Jones Industrial Average (DJX). However, due to upcoming elections in the U.S., the volatility of these indices has increased. Which of the following best describes the impact on index options?
A
The increase in volatility will increase the prices of call index options but decrease the prices of put index options.
B
The increase in volatility will decrease the prices of call index options but increase the prices of put index options.
C
The increase in volatility will decrease the prices of both call and put index options.
D
The increase in volatility will increase the prices of both call and put index options.
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