Economics multiple choice question put option?

Question

The premium on an existing put option should ----- when there is an increase in the expected short-run volatility of the stock proce.

a)be negative

b)decline

c)increase

4)be uncertain

Thanks any detail would be much appreciated

Answer 1

Increase.

A put is an option to sell stock at some fixed price. If a stock becomes more volatile then the existence of a guaranteed sale price for that stock becomes more valuable and its premium increases.

Answer 2

A put option is a right to sell a given security. It's essentially a bet that the price will drop.

Puts have a premium when the price has dropped below the exercise price since the time that the put was bought. This premium exists because the holder can sell the security for more than market value.

Although I could see the answer going either way, the premium should increase during heightened volatility because put and call options are hedges - insurance, if you will, against volatility. As such, demand for these instruments increases, which pushes up the price, which only serves to further increase the premium.

Answer 3

The premium on an existing put option should increase when there is an increase in the expected short-run volatility of the stock price.

Answer c) is correct.

As volatility increases, both higher and lower stock prices become more likely. Hence, both call and put options increase in value.

You can verify this result by increasing the volatility in an online option price calculator like http://www.option-price.com/ and observe the price change.

Answer 4

a) be negative.

With a put option you will lose if the share increases in value, will you not?

Options are for City people, no one else. You'd do better opening a betfair account and laying horses in races. Occasionally you'll have to fork out but in the main you'll rake it in.