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).
b) The wider and lower distribution (in pink).
The expected gain increases when the probability of extreme underlying values increase.
Hence the probabilities corresponding to underlying values, at expiration, that are far from the current underlying value increase when the probabilities corresponding to underlying values close to its current value decrease.