Hence, implied volatility will be the same for calls and puts. LO 16.2 Put-call parity indicates that the deviation between market prices and Black-Scholes-Merton prices will be equivalent for calls and puts. LO 16.1 When option traders allow implied volatility to depend on strike price, patterns of implied volatility resemble volatility smiles. Topic 16 Cross Reference to GARP Assigned Reading – Hull, Chapter 20 Instead of a volatility smile, price jumps would generate a volatility frown, as in Figure 3.įigure 3: Volatility Smile (Frown) W ith Price Jump Implied volatility Away-from-the-money options exhibit a lower implied volatility than at-the-money options. The usual result, however, is that at-the-money options tend to have a higher implied volatility than either out-of-the-money or in-the-money options. Implied volatility is affected by price jumps and the probabilities assumed for either a large up or down movement. This would cause the underlying distribution to become bimodal, but with the same expected return and standard deviation as a unimodal, or standard, price-change distribution. One reason may be the expectation of a significant news event that causes the underlying asset to move either up or down by a large amount. Price jumps can occur for a number of reasons. LO 16.9: Explain the impact of a single asset price jump on a volatility smile.
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