Chapter 03 · Section 3.1

Adjusted Distribution-1

Again consider the call with an exercise price of 40. Which probability distribution gives the highest call premium?

a) The thiner and taller distribution (in green).
No. In this case, the probabilities close to the maximum (those corresponding to underlying values at expiration close to its current value) have a higher value than in the case of distribution (b), thereby giving a higher weight to smaller gains.
b) The wider and lower distribution (in pink).