Significance of Volatility in Option Pricing

This paper examines the significance of volatility in option pricing considering that the option’s theoretical price depends on the accuracy of this parameter’s estimation. One of the assumptions of Black-Scholes model according to which the volatility is a constant parameter and may be determined based on historical data is not realistic. Thus it is considered that a more appropriate estimate of volatility is implied volatility. This study investigates the correlation between implied volatility and strike price known as volatility smile and the relationship between volatility and option’ s maturity – the volatility term structure. Testing these correlations on the Romanian options market is quite difficult because of the low market’s liquidity.