The Intelligent Investor’s Guide to Option Pricing  •  69
Now let’s say that our analysis is absolutely right. Just after we buy the 
call options, the company makes its announcement, and the shares pop up 
by 5 percent. This changes the strike–stock price ratio from 1.05 to 1.00. 
All things being held equal, this should increase the price of the option 
because there would be a larger portion of the range of exposure contained 
within the BSM cone.
However, as the stock price moves up, let’s assume that not everything 
remains constant but that, instead, implied volatility falls. This does hap-
pen all the time in actuality; the option market is full of bright, insightful 
people, and as they recognize that the uncertainty surrounding a product 
announcement or whatever is growing, they bid up the price of the options 
to try to profit in case of a swift stock price move.
In the preceding diagram, we’ve assumed an implied volatility of 35 
percent per year. Let’s say that the volatility falls dramatically to 15 percent 
per year and see what happens to our diagram:
20
25
30
35
40Stock Price
45
50
55
60
Advanced Building Corp. (ABC)
65
Stock price jumps
Implied volatility drops
GREEN
The stock price moves up rapidly, but as you can see, the BSM cone shrinks 
as the market reassesses the uncertainty of the stock’s price range in the 
short term. The tightening of the BSM cone is so drastic that it more than 
offsets the rapid price change of the underlying stock, so now the option is 
actually worth less!