Question

The buyer of a call option on a stock will benefit if the underlying stock price _____, or if the volatility of the stock's price _______.

Increases; increases

Increases; decreases

Decreases; decreases

Decreases; increases

Answer 1

Dear Student,

The question is highly conceptual which is based on the understanding of the options.

Here is the solution :

The right answer is "increases, increases".

Reasons -

1) The buyer of the call option will receive profit if the price go above the exercise price. Thus, buyer of the call option always seek that price increases.

2) Let us first interpret the Volatility - "Higher volatility means higher upside risk or higher downside risk".

- When there is downside risk, the buyer of the call option will forego the premium.

- When there is upside risk, the buyer of the call option will take in the profits.

This is the reason that the buyer of the call option always seeks that volatility increases.