Non-sequitur regarding putable options? 207, expression, regarding, increase

kickthatcfa

pg. 207 in the Schweser text:
“As such, it can be seen in the expression that the value of a putable bond will also increase as volatility increases.  Intuitively, this makes sense; investors are willing to pay more for a bond that gives them the right to sell it at a price greater than the market value.”
The second sentence doesn’t quite follow for me, because if so we are assuming volatility corresponds with a drop in price.  Why is that?  Shouldn’t there be volatility also if the price rises a lot?  I mean this goes with the VIX only going up when prices drop.  Could someone explain to me why we assume volatility only goes up when prices drop and not the other way around?  Or am I missing something?

Bluetick1010

pmond wrote:
if so we are assuming volatility corresponds with a drop in price.
Could someone explain to me why we assume volatility only goes up when prices drop and not the other way around?
These two statements are not equivalent. We aren’t assuming that volatility only goes up when price drops. Increased volatility can result in a greater probability of both larger positive and negative price swings. Investors will pay more for the put because it will allow them to profit from the larger price decreases but not suffer a loss from larger price increases.
EDIT: I misread the original post, so the above is in reference to a general put option, but the reasoning is the same.

ishfaque

I’ll have a look at the wording in the text when I get home, but isn’t the confusion here simply caused by the fact that they are talking about “puttable” bonds only, not callable bonds, therefore the payoff or protection only applies to prices falling.
So, if vol increases, there is a greater chance that the bond will either increase or decrease in price by larger amounts.  If it increases in price dramatically (as implied it might do by the increase in vol), no problem, you don;t need to use the insurance provided by the put.  If the price drops dramatically (as implied it might do by the increase in vol), you exercise your insurance.  
Does this answer your question? Sorry, the wording of your question and lack of context without seeing the text makes it difficult for me to understand your question.

brk1yn

Well that makes at least more sense.  I was ignoring the fact we were talking about puttable bonds!  Thanks.

JPSem

This makes sense, but it isn’t a function of volatility to me.  Saying that the value increases because of an increase in volatility means you should be saying: “investors are willing to pay more for a bond that gives them the right to sell it at a price that rises or falls a lot.”
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Yeah you are getting it right! Investors are willing to pay more for more volatility.
I even agree with what S2000Magician has explained.. he has given a very gud example too.
The logic is all this “increased volatility means increased possibility of making increasing gains”.. And being a put option, in case the price rises, he has the RIGHT not to exercise the option(I am sure you know this).. Thus forget the fact of prices going up for a put option holder.. If he expects volatility of the prices to be very high, he expects the price to fall steeply and thus make gud profit..
Correct me if i m missing something