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

question 9

Multiple Choice

An option-trading firm is using the Black-Scholes (1973) model (with the same constant volatility for all strikes) to price index options. Market sentiment is that the stock return volatility is stochastic and changes in volatility are negatively correlated with stock returns. 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:

Cost Alternatives

Different cost scenarios or options evaluated in decision-making processes.

Product Cost

The total cost associated with producing a product, including direct labor, direct materials, and manufacturing overhead.

Variable Costs

Expenses that vary directly with levels of production or sales volume.

Cost Behaviour

The way in which costs change or remain stable in relation to variations in business activity levels, categorized into fixed, variable, and mixed costs.