AN EMPIRICAL ANALYSIS OF BLACK-SCHOLES OPTION PRICING MODEL FOR

SELECTED STOCKS FROM DIFFERENT SECTORS

-

Ayushmaan Chatterjee

ABSTRACT :
Option pricing plays a major role in Indian market. The paper has tried to explain the
derivative market in brief and how option pricing works in exchange of derivatives. BlackScholes option pricing Model is one the standard models used for analysis of market and
market premiums. An attempt is made in this paper to test empirically the relevance of BlackScholes options pricing model in Indian Derivative market with specific reference to selected
stock options from different sectors. I have tried to check in this specific paper hwo BSOP
model can be used in various sectors of Indian market. The calculation of volatility has been
a complicated part in the application of BSOP model. High volatility stocks dont yield
desired results in European and Indian markets. I have tried to compute the historical
volatility separately for every stock which can be used in the analysis. Results of the paired
sample T-test revealed that there is no significant difference between the expected option
prices calculated thorough Black-Scholes. NSE website gives all the data related to strike
prices, settle prices and all the other data which have been used in this paper.

INTRODUCTION
DERIVATIVES
A Derivative is an instrument whose values is derived from the value of one or more
underlying assets, which can be commodities, precious metals, currency, bonds, stocks,
stocks indices, etc. Four most common examples of derivative instruments are Forwards,
Futures, Options and swaps.
Derivatives either be traded over-the-counter (OTC) or on an exchange. OTC derivatives
constitute the greater proportion of derivative existence and are unregulated, whereas
derivatives traded on exchanges are standardized. OTC derivatives generally have greater risk
for the counter party than do standardized derivatives.

TYPES OF DERIVATIVES
FORWARD CONTRACTS
A forward contract is a customized contract between two parties, where settlement takes
place on a specific date in future at a price agreed today.
FUTURES MARKET
Futures are exchange-traded contracts to sell or buy financial instruments or physical
commodities for a future delivery at an agreed price. There is an agreement to buy or sell a
specified quantity of financial instrument commodity in a designated future month at a price
agreed upon by the buyer and seller. To make trading possible, BSE specifies certain
standardized features of the contract.
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HISTORY OF DERIVATIVE MARKET

Derivatives exchanges have existed for a long time. The Chicago Board of Trade was
established in 1848 to bring farmers and merchants together. Initially its main task was to
standardize the quantities and qualities of the grains that were traded. Within a few years the
first future-type contract was developed. It was known as to-arrive contract. Speculators
soon became interested in the contract and found trading the contract to be an attractive
alternative to trading the grain itself. A rival futures exchange, the Chicago Mercantile
Exchange was established in 1919. Now futures exchanges exist all over the world.
The Chicago Board Options Exchange started trading call option contracts on 16 stocks in
1973. Options had traded prior to 1973, but the CBOE succeeded in creating an orderly
market with well defined contracts. Put option contracts started trading on the exchange in
1977. The CBOE now trades options on well over 1,000 sticks and many different stock
indices. Like futures, options have well over 1,000 sticks and many different stock indices.
Like, futures options have proved to be very popular contracts. Many other exchanges
throughout the world now proved to be very popular contracts. Many other exchanges
throughout the world now trade options.
DERIVATIVES MARKET IN INDIA
Equity derivatives have a long history in India. Options of various kinds called teji (call
options), mandi (put options), and fatak (straddles) traded in unorganized markets as early as
1900 in Mumbai. However, derivatives markets suffered a setback in 1956 when the
Securities Control and Regulation Act (SCRA) banned what was considered to be undesirable
speculations in securities and again in 1969 when forward trading contracts were banned.
BSE created history on June 9, 2000 by launching the first Exchange-traded Index Derivative
Contract in India i.e. futures on the capital market benchmark index the BSE Sensex. The
inauguration of trading was done by Prof. J.R. Varma, member of SEBI and chairman of the
committee which formulated the risk containment measures for the derivatives market.
In sequence of the product innovation, BSE commenced trading in Index Options on Sensex
on June 1, 2001, stocks on July 9, 2001 and Single Stock Futures were launched on
November 9, 2002.

CURRENT PERFORMANCE OF INDIAN DERIVATIVES MARKET

The NSE and BSE are two major Indian markets have shown a remarkable growth both in
terms of volumes and numbers of traded contracts. Introduction of derivatives trading in
2000, in Indian markets was the starting of equity derivative market which has registered on
explosive growth and is expected to continue the same in the years to come. NSE alone
accounts 99% of the derivatives trading in Indian markets. Introduction of derivatives has
been well received by stock market players. Derivatives trading gained popularity after its
introduction in very short time. If we compare the business growth of NSE and BSE in terms
of number of contracts traded and volumes in all

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products, the NSE traded 636132957 total contracts whose total turnover is Rs.16807782.22
cr in the year 2015-16 in futures and options segment while in currency segment in
483212156 total contracts have traded whose total turnover is Rs.2655474.26 cr in same year.
In case of BSE the total numbers of contracts traded are 150068157 whose total turnover is
Rs.3884370.96 Cr in the year 2015-16 for all segments. In the above case we can say that the
performance of BSE is not encouraging both in terms of volumes and numbers of contracts
traded in all product categories.

OPTIONS CONTRACTS
An option contract involves two parties, the writer who sells the option and the holder who
purchases it. The holder of an option contract has the right but not the obligation to either buy
or sell the underlying asset at a predetermined price in the future. If the contract gives the
holder the right to purchase the underlying asset at a predetermined price from the other party
the contract is known as a call option. If the contract gives the owner the right to sell the
underlying asset at a predetermined price from the other party the contract is known as a put
option.
An option contract that can be exercised at any time up until its maturity date is known as an
American option, whilst one that can only be exercised on the expiration date is known as a
European option.
Indian market is also based on the European option as the option contract can only be
exercised on the expiration date.

Objectives

1. To forecast the volatility of the underlying stocks of selected options.

2. To study the relevance of Black-Scholes Option pricing model.

Hypothesis

H0: There is no significant difference between the model prices and market prices.
H1: There is a significant difference between the model prices and market prices.

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Research Design

This study is an applied research as it intends to find the relevance of Black-Scholes Model in
Indian Derivative Market. Study population constitutes all the stock options traded on NSE.
Deliberate Sampling method is applied. The actively traded stock options are selected from
different sectors are selected to show that BSOP model can used in all kind of sectors.
Sample comprises ITC, Reliance, Tata Steel, DLF. The historical data has been collected
from the NSE website. Annualised volatility has been computed based on the daily closing
prices of the calendar year 2015. Interest on 7.4 Government securities 2019 is taken as proxy
for risk free rate. Actual option prices of January, February and March 2016 are used for
comparing with the model prices. Pricing is made in one month advance for two strike
prices, one at the ITM and another one OTM.

THE BLACK-SCHOLES OPTION PRICING FORMULA

In a famous paper Fischer Black and Myron Scholes (1973) derived a formula for the pricing
of options. The formula applies to European options although more sophisticated versions
exist to deal with the pricing of American options. It is widely accepted option pricing model.
The model takes into account, spot price, variance, and strike price, time to expiry and risk
free rate. The formula for computing option price is as under:

Call Option Premium

Put option Premium

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VOLATILITY USED IN BLACK-SCHOLES OPTIONS PRICING MODEL

Volatility in the Black-Scholes option Pricing Formula can be measured by historical

volatility, the most common method of calculation being he annualized standard of daily,
weekly or even monthly changes in prices. The annualized price volatility is obtained by
multiplying the calculated sample standard deviation by the number of periods :

For weekly data :

= 52 x weekly standard deviation
For monthly data :
=12 x monthly standard deviation
For daily data :
=252 x daily standard data

The volatility used is therefore the annualized standard deviation of the changes in prices,
which are most easily calculated by taking the natural log relative prices.

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ITC CALL OPTIONS

Observed Date

Date of
Expiration

28-Dec-2015
(326.20)

31-Jan-2016

28-Jan-2016
(318.55)

25-Feb-2012

29-Feb-2015
(295.65)

31-Mar-2016

Strike Price

Market Premium

Model Premium

330

6.60

8.14

340

3.20

4.45

330

3.95

4.97

340

1.75

2.47

330

1.70

0.63

340

1.05

0.22

t-Test: Paired Two Sample for Means

Market premium

Model Premium

Mean

3.041666667

3.48

Variance

4.189416667

8.92936

Observations

Pearson Correlation

0.971506483

Hypothesized Mean Difference

df

t Stat

-0.966242011

P(T<=t) one-tail

0.189150304

t Critical one-tail

2.015048372

P(T<=t) two-tail

0.378300607

t Critical two-tail

2.570581835

The p value of excel output as shown in Table 1 is greater than 0.05. Hence, null Hypothesis
is accepted. There is no significant difference between the expected price and actual price of
the ITC call options.

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TATASTEEL CALL OPTIONS

Observed Date

Date of
Expiration

28-Dec-2015
(254.10)

31-Jan-2016

28-Jan-2016
(254.20)

25-Feb-2012

29-Feb-2015
(249.10)

31-Mar-2016

Strike Price

Market Premium

Model Premium

300

1.00

0.67

310

0.55

0.30

300

1.25

0.68

310

0.70

0.31

300

1.20

0.41

310

0.75

0.17

t-Test: Paired Two Sample for Means

Market Premium

Model Premium

Mean

0.908333333

0.423333333

Variance

0.081416667

0.043826667

Observations

Pearson Correlation

0.717618845

Hypothesized Mean Difference

df

t Stat

5.976732918

P(T<=t) one-tail

0.000939253

t Critical one-tail

2.015048372

P(T<=t) two-tail

0.001878506

t Critical two-tail

2.570581835

The p value of excel output as shown in Table 2 is less than 0.05. Hence, null Hypothesis is
rejected. There is a significant difference between the expected price and actual price of the
TATA STEEL options.

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RELIANCE CALL OPTIONS

Observed date

Date of
expiration

28-Dec-2015
(1010.40)

31-Jan-2016

28-Jan-2016
(1016.90)

25-Feb-2016

29-Feb-2016
(966.65)

31-Mar-2016

Strike Price

Market Premium

Model Premium

1040

17.20

19.14

1020

25.60

27.35

1040

21.60

21.78

1020

30.35

30.68

1040

14.05

15.88

1020

13.25

10.86

t-Test: Paired Two Sample for

Means
Market Premium

Model Premium

Mean

20.34166667

20.94833333

Variance

45.82941667

53.42217667

Observations

Pearson Correlation

0.975008505

Hypothesized Mean Difference

df

t Stat

-0.893829418

P(T<=t) one-tail

0.20618282

t Critical one-tail

2.015048372

P(T<=t) two-tail

0.41236564

t Critical two-tail

2.570581835

The p value of excel output as shown in Table 3 is greater than 0.05. Hence, null Hypothesis
is accepted. There is no significant difference between the expected price and actual price of
the Reliance call options.

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DLF CALL OPTIONS

Observed Date

Date of
Expiration

1-Jan-2016
(121.55)

29-Jan-2016

29-Jan-2016
(96.35)

25-Feb-2016

29-Feb-2016
(88.95)

31-Mar-2016

Strike Price

Market Premium

Model Premium

110

13.50

13.87

105

18.00

17.98

110

1.50

1.10

105

2.45

2.05

110

0.70

0.27

105

1.05

0.61

t-Test: Paired Two Sample for Means

Market Premium

Model Premium

Mean

6.2

5.98

Variance

57.091

61.39048

Observations

Pearson Correlation

0.999737811

Hypothesized Mean Difference

df

t Stat

1.631645251

P(T<=t) one-tail

0.081841399

t Critical one-tail

2.015048372

P(T<=t) two-tail

0.163682798

t Critical two-tail

2.570581835

The p value of excel output as shown in Table 4 is greater than 0.05. Hence, null Hypothesis
is accepted. There is no significant difference between the expected price and actual price of
the DLF call options.

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TATA STEEL PUT OPTIONS

Observed Date

Date of
Expiration

28-Dec-2015
(254.10)

31-Jan-2016

28-Jan-2016
(254.20)

25-Feb-2012

29-Feb-2015
(249.10)

31-Mar-2016

Strike Price

Market Premium

Model Premium

300

47.10

44.80

310

55.15

54.37

300

46.60

44.71

310

52.95

54.28

300

39.95

49.54

310

53.10

59.24

t-Test: Paired Two Sample for Means

Mean

49.14166667

Model
Premium
51.15666667

Variance

32.27741667

34.00026667

Observations

Pearson Correlation

0.648529877

Hypothesized Mean Difference

Df

t Stat

-1.022321413

P(T<=t) one-tail

0.176759758

t Critical one-tail

2.015048372

P(T<=t) two-tail

0.353519516

t Critical two-tail

2.570581835

Market Premium

The p value of excel output as shown in Table 5 is greater than 0.05. Hence, null Hypothesis
is accepted. There is a no significant difference between the expected price and actual price
of the TATA STEEL put options.

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SBI PUT OPTIONS

Observed Date

Date of
Expiration

28-Dec-2015
(228.90)

31-Jan-2016

28-Jan-2016
(185.25)

25-Feb-2012

29-Feb-2015
(158.75)

31-Mar-2016

Strike Price

Market Premium

Model Premium

190

0.35

0.80

180

0.00

0.01

190

10.95

8.48

180

6.35

3.70

190

32.00

30.26

180

22.50

20.80

t-Test: Paired Two Sample for Means

Market Premium

Model Premium

Mean

12.025

10.675

Variance

164.59875

150.16287

Observations

Pearson Correlation

0.995768507

Hypothesized Mean Difference

Df

t Stat

2.565254571

P(T<=t) one-tail

0.025162191

t Critical one-tail

2.015048372

P(T<=t) two-tail

0.050324382

t Critical two-tail

2.570581835

The p value of excel output as shown in Table 6 is greater than 0.05. Hence, null Hypothesis
is accepted. There is a no significant difference between the expected price and actual price
of the SBI put options.

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CONCLUSION
Through the above analysis we come to the conclusion that BSOP model can be used to
analyse the stocks in Indian market. The derivatives traded follow the BSOP model and
premium obtained by formulae are almost same and Paired sample T-test results indicate that
this model can be applied for stock options from every sector. However, in one out of 6 cases,
there is a difference between expected price and market price of the option. Options may be
under-priced or overpriced in the market. Hence, we can use Black Scholes Option Pricing
Model to analyze the stock option of all the sectors.

REFERENCES
1. Fischer Black and Myron Scholes, The Pricing of Options and Corporate Liabilities, The
Journal of Political Economy, Vol. 81, No. 3, May - June 1973, pp. 637-654.
2. Finance and Financial Market, Keith Pilbeam, Palgrave Macmillan, pp 388-407.
3. Dr. Panduranga V, Relevance of Black-Scholes Option Pricing Model in Indian
Derivatives Markets A Study of Cement Stock Options, IRCS INTERNATIONAL
JOURNAL OF MULTIDISCIPLINARY RESEARCH IN SOCIAL & MANAGEMENT
SCIENCES ISSN:2320-8236
VOLUME:1,ISSUE:4
OCTOBER-DECEMBER2013
4. Hull, J., Options: Futures and other Derivatives, PHI.
5. Dr Panduranga V, AN EMPIRICAL ANALYSIS OF BLACK-SCHOLES OPTION
PRICING MODEL FOR SELECT BANKING STOCKS, Vol.1 Issue-2 July December
2013, Vidyaniketan Journal of Management and Research
6. . Kumar SSS, Financial Derivatives, PHI
7. Navaneet and Manish Bansal, Derivatives and Financial Innovations, TMH.

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