Question

Call prices are directly related to the stock’s volatility, yet higher volatility means that the stock price can go lower. How would you resolve this apparent paradox?

Answer 1

A call option gives the right but not the obligation to purchase the stock. The option will only be exercised when it is favorable for the option buyer. So, the downside is protected which means the premium would go waste when stock price goes down but higher volatility means higher upside as well so profits from call increase. As downside is limited but upside is unlimited, higher volatility means higher prices despite higher volatility meaning price going in both directions.