Question

Consider call and put options. Assume that the price of an underlying asset evolves without drift and with a given volatility. Compare and contrast the response of the price of the call and put options to a decrease in the volatility of the underlying asset. Provide diagrams to support your answer.      

Answer 1

Changes in volatility is directly related to the prices of both the call option and put option.

when there is a positive change in the volatility, the prices of both the call option and put option will go on increasing.

When there is a negative change in the volatility,the prices of both the call option and put option will come down because there would be lesser chances of higher fluctuations to achieve the desired output and it will be less Preferred by the traders.

hence, it can be said that volatility is directly related to the prices of the call and put option and the change in volatility is always a reason for change in pricing of various calls and puts.