An Option-Trading Firm Is Using the Black-Scholes (1973)model to Price

question 21

Multiple Choice

An option-trading firm is using the Black-Scholes (1973) model to price their options using the same level of volatility for all strikes.The market anticipation is that sharp negative gapping behavior is likely given that sudden recessionary information is being released in spurts.By using the Black-Scholes model with a constant volatility the firm is

• A)Underpricing out-of-the-money calls relative to in-the-money puts.
• B)Underpricing out-of-the-money puts relative to in-the-money calls.
• C)Underpricing out-of-the-money puts and in-the-money puts relative to those at-the-money.
• D)Underpricing out-of-the-money puts relative to those at-the-money.

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Definitions:

Agriculture

The practice of cultivating soil, growing crops, and raising livestock for food, fiber, medicinal plants, or other products used to sustain and enhance human life.

Law of Diminishing Returns

An economic principle stating that adding more of one factor of production, holding all else constant, will at some point yield lower per-unit returns.

Dramatic Yields

Significant increases in productivity, often used in the context of agricultural output resulting from new technologies or methods.

Pesticides

Chemicals used to kill or manage the population of pests, including insects, weeds, and fungi, that threaten agricultural production and public health.