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:

Market Value

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

Financial Position

A snapshot of the resources, liabilities, and equity of an entity at a specific point in time, illustrating its economic standing.

Cash Flow From Assets

The total amount of money being transferred in and out of a company's operations, investments, and financing, specifically relating to its assets.

Cash Flow To Creditors

The amount of cash companies pay to their creditors and lenders, including payments for interest and principal on debt.