Effect of Return and Volatility

Calculation on Option Pricing:

Using BANKNIFTY
“Derivatives - The risk never
leaves the system - It finds
taker who believes the risk
is acceptable....until they
lose everything”
Abstract of the Research Paper
⊸ Option pricing models are based on a set of observed
parameters as inputs like spot price of the underlying asset,
strike price, time to maturity, risk free interest rate and volatility
which determine the price of the option

⊸ Data for spot price, strike price & time period is readily
available

⊸ Volatility and risk free rate vary through time and market
conditions

⊸ Volatility is estimated using either historical movements or

generated by implication

⊸ Pricing of securities is supposed to be dependent on volatility

of each asset
Methods used in Study
⊸ Data used in the research paper was from Jan 01, 2002 to
Jan 16, 2012 for Bank Nifty, we have taken the data from Jan 01,
2007 to March 17, 2017

⊸ Methods used in the Study are:

I. Effective Holding Period Yield
II. Continuously Compounded Holding Period Yield
III. Rule of 16
IV. High – Low Method

⊸ The Volatility derived from each of the method is used in

Black-Scholes model to get the prices for the Call and Put
options
21,175.05
Closing Price on 17th March, 2017 Volatility Table
Year Effective Holding Period Yield Continuously Compounded HPY Rule of 16 High - Low Method
2007 33.81% 33.77% 34.08% 10.82%
2008 55.34% 55.36% 55.77% 17.27%
2009 44.28% 43.71% 44.63% 13.61%
2010 21.89% 21.91% 22.07% 6.83%
2011 27.45% 27.42% 27.66% 7.68%
2012 22.98% 22.92% 23.16% 10.01%
2013 29.78% 29.70% 30.01% 8.99%
2014 21.04% 20.94% 21.21% 7.29%
2015 22.47% 22.56% 22.64% 6.73%
2016 20.07% 20.04% 20.23% 6.92%
2017 13.73% 13.67% 13.84% 4.24%

5.8602%
91 Day T- Bill Rate
 And we have tables to compare data
Call Prices Calculation
Strike Price Effective Holding Period Yield Continuously Compounded HPY Rule of 16 High - Low Method Actual Price
20,500.00 741.9560 741.5064 742.6753 718.3862249 707.1000
20,600.00 653.3740 652.8066 654.2792 618.6021081 612.6500
20,700.00 568.7355 568.0446 569.8351 518.8579584 517.3000
20,800.00 488.8432 488.0310 490.1331 419.382954 421.2000
20,900.00 414.4673 413.5453 415.9293 321.1883123 337.3000
21,000.00 346.2865 345.2751 347.8884 227.3196023 256.0000
21,100.00 284.8312 283.7586 286.5288 143.8846503 185.0000
21,200.00 230.4373 229.3370 232.1781 78.50086141 126.6000
21,300.00 183.2170 182.1250 184.9451 35.61988298 83.4500
21,400.00 143.0516 142.0023 144.7131 13.0381251 49.8000
21,500.00 109.6055 108.6289 111.1533 3.759866423 26.5000

Put Prices Calculation

Strike Price Effective Holding Period Yield Continuously Compounded HPY Rule of 16 High - Low Method Actual Price
20,500.00 23.5701 23.1205 24.2895 0.000336051 6.8500
20,600.00 34.7767 34.2093 35.6820 0.004824659 9.3500
20,700.00 49.9269 49.2359 51.0264 0.049280469 12.7500
20,800.00 69.8231 69.0110 71.1130 0.362881407 21.1000
20,900.00 95.2358 94.3138 96.6978 1.95684514 33.0000
21,000.00 126.8436 125.8322 128.4456 7.876740539 52.9000
21,100.00 165.1770 164.1043 166.8746 24.23039404 80.8000
21,200.00 210.5716 209.4714 212.3124 58.63521053 118.0000
21,300.00 263.1400 262.0479 264.8680 115.5428375 172.9500
21,400.00 322.7632 321.7138 324.4246 192.7496851 240.0000
21,500.00 389.1057 388.1291 390.6534 283.2600318 305.0000
Findings and Conclusion
⊸ The original study found that all methods gave a close
approximation to the Call Prices; we found that the High-Low
method gave us a close approximation to the actual prices

⊸Also, the original case point that all 4 methods give a close
approximation of the actual prices proved to be true here

⊸ Other significant Observations:

1. Volatility increases the risk premium
2. Longer term options overreact to the changes in the implied
volatility of short maturity options which is the reason behind
the inefficiency
3. Significant difference in the average implied volatility from the
Put and Call options
 Thanks!
Any questions?
Group Members:

Haresh Chugh – A008 “If there is more risk to be borne,

Makrand Kolekar – A025 assuming that expected payoffs from
business investment do not change,
Sourav Modak – A032 then stock prices must fall so that
Mitesh Rohira – A043 investors will continue to hold the
existing stocks. A fall in stock prices
means an increase in expected returns
from stocks”