Why Do Traders Use Volatility Smiles for Pricing Options

question 4

Multiple Choice

Why do traders use volatility smiles for pricing options?

• A) To allow for non-lognormality of the probability distribution of future asset price
• B) Because it is consistent with recent market moves
• C) As a tool to reflect their views about extreme market moves
• D) Because extreme market moves are always more likely than Black-Scholes-Merton assumes

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Definitions:

Market Price

The current price at which an asset or service can be bought or sold in a marketplace.

Liable

Being legally responsible for something, especially in terms of owing money or being obligated to perform under the terms of a contract.

Real Estate Agent

A professional authorized to negotiate and conduct real estate transactions on behalf of sellers and buyers.

Written Offer

A formal proposal presented in written form to engage in a contract or agreement.