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Postby anandrishi88 » Wed Jan 30, 2013 7:52 pm

How option prices are more volatile than the prices of underlying stock?

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Postby content.pristine » Fri Feb 01, 2013 12:25 pm

Hi Anandrishi,
Consider this:
A stock trading at 55.
Call option with strike 50 at T=0 costs $6
Now, if this stock price goes to $57 you can expect the option price to be around $8
For the stock the $2 increase is less than 4% of the stock, but for the call, the $2 increase is 33%!!! Now, if you take these changes over time, the standard deviations of options would be much higher than the underlying stock. This is what we call "base effect".

Hope this helps!!

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