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Empirical Study on Theoretical Option Pricing Model

Authors: Dr. Shailesh Rastogi, Nithya Vetriselvam and Jeffrey Don Davidson

Journal: Prastuti (GLA University)

Publication date: 2018 September

Publisher: Prastuti (GLA University)

URL: click here


Abstract:

An option is a contract giving the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset (a stock or index) at a specific price on or before a certain date. An option is a derivative. In the case of a stock option, its value is based on the underlying stock (equity) and if itis an index option, its value is based on the underlying index. An option is a security, justlike a stock or bond, and constitutes a binding contract with strictly defined terms and properties. Some people remain puzzled by options. The truth isthat most people have been using options for some time, because optionality is built into everything from mortgages to auto insurance. Several pricing models like Black-Scholes Model, Binomial Option Pricing Model, Stochastic volatility models etc., have been developed over the yearsto calculate the price of the options. The main objective of this paper is to test the consistency of these models by calculating the prices of the options for 175 companies listed in the National Stock Exchange (NSE) using Black – Scholes model and Binomial Tree pricing model, and comparing it with the current market option price. The study also checks the option pricing models for no arbitrage conditions such as the put-call parity using statistical methods.