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:

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The capacity to make decisions independently, free from external control or influence.

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