Varying the Standard Deviation

Figure 24.3 illustrates the impact on option values of varying the standard deviation of the return on the underlying asset. As shown, the effect is positive and pronounced for both puts and calls. In fact, increasing the standard deviation has an almost identical effect on them.

The sensitivity of an option's value to the volatility of the underlying asset is called its vega.2 Once again, the formula is somewhat complicated, so we will omit it. The main thing to understand from Figure 24.3 is that option values are very sensitive to standard deviations, and changes in the volatility of the underlying asset's return can have a strong impact on option values.

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