33 lines
1.2 KiB
Plaintext
33 lines
1.2 KiB
Plaintext
The Intelligent Investor’s Guide to Option Pricing • 61
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volatility of 20 percent per year for this stock. Visually, our assumptions
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yield the following:
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Advanced Building Corp. (ABC)
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5/18/2012 5/20/2013 249 499 749 999
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100
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90
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80
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70
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60
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50
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40
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30
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20
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Date/Day Count
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Stock Price
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GREEN
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A forward volatility of 20 percent per year suggests that after
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three years, the most likely range for the stock’s price according to the
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BSM will be around $41 on the low side to around $82 on the high
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side. Furthermore, we can tell from our investigations in Chapter 2 that
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this option will be worth something, but probably not much—about the
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same as or maybe a little more than the one-year, $60 strike call option
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we saw in Chapter 2.
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4
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Now let’s increase our assumption for volatility over the life of the
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contract to 40 percent per year. Increasing the volatility means that the
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BSM probability cone becomes wider at each point. In simple terms, what
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we are saying is that it is likely for there to be many more large swings in
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price over the term of the option, so the range of the possible outcomes
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is wider.
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Here is what the graph looks like if we double our assumptions
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regarding implied volatility from 20 to 40 percent: |