Most Major Stock Indices, Like the S&P 500, Exhibit an Implied

question 20

Multiple Choice

Most major stock indices, like the S&P 500, exhibit an implied volatility skew. This means if we consider three put options, $P \left( K _ { 1 } \right) , P \left( K _ { 2 } \right) , P \left( K _ { 3 } \right)$ at strikes $K _ { 1 } < K _ { 2 } < K _ { 3 } \leq S$ (where $S$ is the current index level) and the options have implied volatilities $\sigma _ { 1 } , \sigma _ { 2 } , \sigma _ { 3 }$ , respectively, then the most likely pattern is

• A) \(\sigma _ { 1 } < \sigma _ { 2 } < \sigma _ { 3 }\) .
• B) \(\sigma _ { 1 } = \sigma _ { 2 } < \sigma _ { 3 }\) .
• C) \(\sigma _ { 1 } = \sigma _ { 2 } = \sigma _ { 3 }\) .
• D) \(\sigma _ { 1 } > \sigma _ { 2 } > \sigma _ { 3 }\) .

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Definitions:

Bond Investing

The process of investing in bonds, which are debt securities, to earn a return from interest payments and potential price appreciation.

Canada Call

A provision in some bonds that allows the issuer to redeem the bond early, specifically in the Canadian market.

Maturity Date

The specified date on which the principal amount of a bond or other debt instrument is due to be paid in full.

Default Probability

The likelihood that a borrower will be unable to make required debt payments, leading to a default.