Lorenzo Bretscher Derivatives Spring 2022

1. Use the following inputs to compute the price of a European call option: S = $100, k = $50,
r = 0.06, σ = 0.30, t = 0.01, δ = 0.

a) What is the Black-Scholes price of this option?

50.0299.
b) What is the vega for this option? What is your intuition/justification for the value?
Almost 0. Vega is measuring the sensitivity of the option price with respect to a change
in the volatility. Note that we only have very little time left to maturity. The given
volatility won’t lead to large movements in the stock price over such a short period of
time.

The vega can be calculated as follows:

1 1 2√ 10 1 2
vega = 100 √ e− 2 d1 T − t = √ e− 2 23.14 = 5.34E −116
2π 2π

c) Recompute the option price with volatilities ranging from 0.05 to 1.00. What are the
resulting option prices and vega? What is your intuition/explanation? What happens if
you set σ = 5.00 (i.e., 500%)?
Option price does not change much - stays almost the same as in a). Also, the vega does
not move much and remains almost 0 in all cases. Vega is measuring the sensitivity of
the option price with respect to a change in the volatility. Note that we only have very
little time left to maturity. Even if there is a lot of volatility, it will not be able to move
the stock price significantly over such a short period of time. Only if we choose a very
high volatility of 500 percent, we see that the option’s price moves a significant amount.
d) What do you conclude about difficulties in computing implied volatility for very short-
term, deep in-the-money options?
This demonstrates that it is very difficult, if not impossible, to calculate implied volatil-
ities for deep in-the-money call options with short maturities. Effectively, the implied
volatility estimates are not very reliable as tiny price changes will lead to drastic move-
ments in implied volatility.