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

question 3

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:

Fatty Acids

Essential, long-chain hydrocarbons found in fats and oils, important for energy and cell functions.

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A type of fat found in plants and fish that contains more than one unsaturated carbon bond in its molecules, known to be beneficial for heart health.

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The total amount of energy consumed in the form of food or drinks, measured in kilocalories (also known as Calories), crucial for maintaining body functions and energy levels.

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