AppliedMultiple choice
When the model meets the market · Part 2 of 3
A desk prices one-year options on an equity index with Black–Scholes at a single volatility of 20%. The market prices the at-the-money option at 20% implied volatility but the 80-strike put at 28%.
What does pricing the low-strike put at a higher implied volatility say about the market’s risk-neutral distribution for the index?
- AIt has a fatter left tail than a lognormal
- BIt is lognormal but with a higher volatility of 28% for every outcome
- CIt has a fatter right tail, so rallies are priced as likelier than falls
- DIt is symmetric, and the 8-point gap only reflects demand for insurance
The worked solution is in Premium
The answer, the full working and the one idea to take away – for this and all 1,322 questions in the bank. Answer it in practice and your working is marked, with a known mistake named when you make one.
Learn the method
More option pricing models questions
- What does the Black–Scholes formula give for a one-year at-the-money call on a…Foundation
- A European call at the $100 strike has an implied volatility of 22%.Applied
- Equity index options show higher implied volatility for low strikes than for high strikes.Applied
- Which answer to "what is wrong with Black–Scholes?" is strongest in an interview?Advanced
- What is the essential difference between a local volatility model and a…Advanced
- When is the Bachelier, or normal, model preferred to Black and Scholes?Advanced