Options Trading Options Pricing and Valuation 3 — Questions and Answers
Question 1: An option's extrinsic value is also known as:
- Time value (Correct answer)
- Intrinsic value
- Delta value
- Strike value
Correct answer: Time value
Extrinsic value is synonymous with time value — the portion of the option premium beyond its intrinsic value.
Question 2: When implied volatility rises sharply, what typically happens to option premiums?
- Both put and call premiums increase (Correct answer)
- Only call premiums increase
- Only put premiums increase
- Both put and call premiums decrease
Correct answer: Both put and call premiums increase
Rising implied volatility increases uncertainty, which inflates both call and put option premiums simultaneously.
Question 3: What is 'IV crush' in options trading?
- A sharp drop in implied volatility after a major event like earnings (Correct answer)
- A strategy to sell high-IV options
- An increase in open interest after earnings
- The process of calculating implied volatility
Correct answer: A sharp drop in implied volatility after a major event like earnings
IV crush refers to the rapid decline in implied volatility that typically occurs after a major anticipated event like earnings releases, causing option premiums to fall sharply.
Question 4: Which options pricing variable most directly affects an option's theoretical fair value according to Black-Scholes?
- Implied volatility (Correct answer)
- Open interest
- Trading volume
- Bid-ask spread
Correct answer: Implied volatility
Implied volatility is the most dynamic and impactful input in Black-Scholes, directly driving the model's output for option fair value.
Question 5: What does a 'volatility skew' indicate in equity options markets?
- Out-of-the-money puts have higher IV than out-of-the-money calls (Correct answer)
- All strikes have the same implied volatility
- Out-of-the-money calls are more expensive than puts
- Implied volatility is constant across all expirations
Correct answer: Out-of-the-money puts have higher IV than out-of-the-money calls
Volatility skew in equities shows that OTM puts typically carry higher implied volatility than OTM calls, reflecting demand for downside protection.
Question 6: An option trading at its intrinsic value only (zero time value) is said to be:
- Deeply in the money (Correct answer)
- At the money
- Out of the money
- Fairly valued
Correct answer: Deeply in the money
Deep in-the-money options often trade near their intrinsic value because they have very little time value remaining relative to their total premium.
Options Trading Options Pricing and Valuation 3
An option's extrinsic value is also known as: