A company is negotiating for the option to develop a platinum mine. Under the terms of the option contract, the company would be able to purchase the development rights to the mine one year from now for an exercise price specified today. If, during the negotiations over the option contract, the volatility of the price of platinum increases, the company should expect to pay a higher price for the development option.

Question

Quizplus · Accepted Answer

An increase in volatility generally leads to an increase in option prices, as there is a higher probability of the underlying asset (in this case, platinum) fluctuating in value, which increases the potential payoff for the option holder. Therefore, the company should expect to pay a higher price for the development option if the volatility of the price of platinum increases during negotiations.

A Company Is Negotiating for the Option to Develop a Platinum