Deck 19: Volatility Smiles

Question 1

Why is there an inverse relationship between implied volatility and strike price in equity options? _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __ _ ___

Answer 1

The increase of a company's equity value reduces leverage and thus its volatility. 'Crashophobia' might be another reason.

Question 2

A volatility smile such as that seen for foreign currency options can be caused by: choose two)

A) The fact that currencies are traded in different countries at different times of the day
B) The fact that volatility is not constant
C) The fact that the activities of central banks cause occasional jumps in the exchange rate
D) The fact that interest rates may be different in the two countries

Answer 2

B AND C

Question 3

Indicate whether the tails mentioned below are fatter or thinner than the tails for a lognormal distribution based on the implied volatility.
i) Left tail of foreign currency implied distribution _ _ _ _ _ _
ii) Right tail of foreign currency implied distribution _ _ _ _ _ _
iii) Left tail of stock index implied distribution _ _ _ _ _ _
iv) Right tail of stock index implied distribution _ _ _ _ _ _

Answer 3

i) fatterii) fatteriii) fatteriv) thinner

Question 4

Which of the following is true? choose one)

A) The volatility skew for equities is much more pronounced now than it was in 1987.
B) The volatility skew for equities was much more pronounced in 1987 than it is now.
C) The volatility skew for equities is consistent with the Black-Scholes model.
D) The volatility skew for equities is similar to that for foreign currencies.

Question 5

Which of the following is true? choose one)

A) The volatility smile for European puts is the same as that for European calls.
B) The volatility smile for European puts is the same as that for American puts.
C) The volatility smile for European calls is the same as that for American calls.
D) The volatility smile for American puts is the same as that for American calls.

Question 6

In a volatility smile diagram:
i) What is plotted on the horizontal axis? _ _ _ _ _ _
ii) What is plotted on the vertical axis? _ _ _ _ _ _