An Option-Trading Firm Is Using the Black-Scholes (1973) Model (With

Multiple Choice

An option-trading firm is using the Black-Scholes (1973) model (with the same constant volatility for all strikes) to price index options. Market sentiment is that the stock return volatility is stochastic and changes in volatility are negatively correlated with stock returns. By using the Black-Scholes model with a constant volatility the firm is

A) Underpricing out-of-the-money calls relative to in-the-money puts.
B) Underpricing out-of-the-money puts relative to in-the-money calls.
C) Underpricing out-of-the-money puts and in-the-money puts relative to those at-the-money.
D) Underpricing out-of-the-money puts relative to those at-the-money.