Chapter 03 · Section 3.1

Volatility

We can easily see the effect of a change in volatility by comparing points A and B in the adjacent graph.

At both points, the underlying stock price is the same. Therefore, we know that the intrinsic value at A and B is identical because:

Call Intrinsic Value = Underlying Value - Exercise Price

Point A however, is below the breakeven plane and has lost money. This is due to the loss of time value resulting from the decreased volatility. An options position is a right to choose. This right is less valuable if the price of the underlying asset over a given time period is certain. Hence - as the underlying stock loses volatility the long options position losses money.