Submitted to: Submitted by:

Prof: Bharat Vira Ankit pal

Sem 3/MMS
A.M.S.I.M.R
 INTRODUCTION
 Option pricing models are mathematical model that use certain
variables to calculate the theoretical value of option.
 The theoretical value of an option is an estimated of what an
option should worth using all known inputs.
 It help to estimate of the fair value of an option, finance,
professionals could adjust their trading strategies and portfolio.
 Option pricing models are powerful tools for finance professional
involved in option trading.
 OPTION

 An option is a contract that gives the holder a right, without

any obligation, to buy or sell an asset at an agreed price on or
before a specified period of time.
 The option to Buy asset is known as a call option.
 The option to Sell an asset is called a put option.
 the price at which option can be exercised is called an exercise
price.
 The asset on which the out or call option is created is referred
to as the underlying asset.
 TYPES OF OPTION

 European style options may be exercised only at the expiration

date.

 American style option can be exercised anytime between

purchase and expiration date.
 TYPES OF OPTION MODEL
Black-Scholes model
 Black-Scholes was discovered in1973 by the economists
Fischer Black and Myron Scholes.

 rt
C  SN (d1 )  Ke N (d 2 )
Where:
S   
2
C = Call option price ln    r  t
S = Current stock K  2 
d1 
K = Strike price  t
r = Risk free interest rate and
t = Time of maturity
N = A normal distribution price
d 2  d1   t
 EXAMPLE

 The share of TIC Ltd are currently priced at 415 and call option
exercisable in three months time has an exercise rate of 400.
Risk free rate of interest is 5% p.a. and standard deviation
(volatility) of share price is 22% .
 Based on the assumption that TIC Ltd. Is not going to declare
any dividend over the next three month, is the option worth
buying for 25.
 SOLUTION

C = S N (d1) - K e^-rt N(d2)

= 415×0.6927 – 400 e^ -(0.05× 0.25)×(0.6529)

= 287.47- 400/1.0126×(0.6529)
= 487.47- 257.91
= 29.56
 S    2

ln    r  t
K   2 
d1 
 t
= ln (415/400)+{0.05+(0.22)^2/2}×(0.25)/(0.22√0.25)
= In(1.0375)+ 0.01855/0.11
= 0.03681+0.01855/0.11
= 0.5033

d2 = d1- 𝜎√t
= 0.5033- 0.11
= 0.3933
 BINOMIAL MODEL

 The binomial option pricing model is an option valuation

method developed in 1997.
 Binomial option price models, the assumption are that are
two possible outcomes, move up or a move down.
 It reduce possibilities of piece changes, while removing
the possibility for arbitrage.
 The model is mathematically simple
 EXAMPLE

 If an investor invest in ABC Ltd Rs.100 for month 6 month in

risk free rate of return which is 10% he will get Rs.105 after 6
months.
So = 100, U = 10 D =10% R = 10% p.a

Rs.110 (u) = 10
ABC Ltd Rs. 100
Rs.90 (d) = 0
Calculation of probability in binomial pricing model

P(U) = (R-D)/(U-D)
= (1.05-0.90)/(1.10-0.90)
= 0.15/0.20 R= Return
D= Down in price
= 0.75 U= Up In price
D= Down in price

P(D)= 1- 0.75
= 0.25
 BINOMIAL MODEL

value of option = (cu× 𝑝) + (𝑐 × 𝑑)/r

= (10 ×0.75)+(0. ×0.25)/1.05
= 7.14