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Summer Internship Report, SIBM Bangalore

Analysis of options pricing: An Application of BlackScholes


Model

Project Report submitted to Symbiosis Institute of Business Management, Bengaluru


in partial fulfilment of the course Summer Internship Programme for the award of the
degree of
Master of Business Administration
Submitted By
Students Name: Sandeep Agrahari
PRN: 12020841095
Under the guidance of
(Prof Dr Bipasha Maity)

SYMBIOSIS INSTITUTE OF BUSINESS MANAGEMENT,


BENGALURU
95/1 & 95/2, Electronic City Phase-1, Hosur Road, Bengaluru 560100

Certificate
This is to certify that Mr. Sandeep Agrahari of MBA, 2012-14
Batch, of Symbiosis Institute of Business Management at
Bengaluru has done the project entitled Analysis of options
pricing: An Application of BlackScholes Model under my
guidance.

Name: Mr. Ravi Kumar


Designation: Assistant professor
Date: 1/07/2013

DECLARATION
I hereby declare that the project work submitted by me entitled Analysis

of options pricing: An Application of BlackScholes Model done


during my Summer Internship Program (SIP) is submitted as a partial fulfillment of
the requirement of MBA program at Symbiosis Institute of Business Management,
Bengaluru.
I also declare that this project has not been submitted nor shall it be
submitted in future for the award of any other degree or diploma in part or full to
any other institution or university.

Place: Bangalore
Agrahari

Name : Sandeep

Date: 01/07/2013

PRN : 12020841095

Acknowledgement
I take this opportunity to extend my sincere thanks to Mr. Vipin P.
Varghese, Regional Coordinator, DBFS for offering a unique platform to earn
exposure and garner knowledge in the field of Trading and Market Analysis.
During the entire project, I am able to say with conviction that I have
immensely benefited from auspicious and prestigious association as a summer intern
with Doha Brokerage and Financial Services .
I wish to express my deep gratitude to Prof Dr Bipasha Maity, Faculty
SIBM who helped me in various ways during our project work. I also would like to
thank Professor Ravi Kumar, Faculty Mentor who guided me regarding this
project throughout the project work.
There are many who I may have left out in acknowledgement, but whose cooperation was indispensable in the fulfilment of the project.

Sandeep Agrahari
PRN No 12020841095
SIBM Bangalore 2012-2014

Table of Contents
Table of Contents of graphs/tables:......................................
Industry Analysis................................................................
Key Features of the Industry........................................................................................................
Major Players...............................................................................................................................
Five Years Trend........................................................................................................................

Company Analysis.............................................................11
Mission.......................................................................................................................................
Vision.........................................................................................................................................
Organization Structure...............................................................................................................
HR Details No. of employees..................................................................................................
Product and Services..................................................................................................................
Customers..................................................................................................................................
Competitors................................................................................................................................
Basic financial Analysis.............................................................................................................
Operational Processes................................................................................................................

Introduction of the Project.................................................18


Objectives of the study......................................................19
Literature Review:.............................................................19
Hypothesis Development...................................................21
Research Methodology:.....................................................21
Data:...........................................................................................................................................
Data Type:.............................................................................................................................
Data Source...........................................................................................................................
Data Tenure:..........................................................................................................................
Analysis Tools:...........................................................................................................................
Black-Scholes Formula:........................................................................................................
Chi Square formula...............................................................................................................
ANOVA (ANalysis Of VAriance):...........................................................................................
Method :.....................................................................................................................................

Limitations of the study.....................................................24


Analysis of Data:...............................................................25
Calculation of Call Price and Variation:.....................................................................................
Sector: Bank..........................................................................................................................
Sector: IT...............................................................................................................................
Sector: Pharmaceuticals........................................................................................................
Analysis of Companies within the Industry:..............................................................................
Sector: Banks.........................................................................................................................
Sector: IT...............................................................................................................................
Sector: Pharma......................................................................................................................

Findings and Conclusions...................................................40


Suggestions......................................................................41
Bibliography.....................................................................42
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Annexure:.........................................................................43

Table of Contents of graphs/tables:


Sr. No.
1
2
3
4
5
6
7
8

Table No.
G-1.1
T-1.1
T-2.1
T-2.2
T-2.3
G-9.1
G-9.2
G-9.3

G-9.4

10
11
12
13
14
15
16
17
18
19

G-9.5
G-9.6
G-9.7
G-9.8
G-9.9
G-9.10
G-9.11
G-9.12
T-9.1
G-9.13

20
21

T-9.2
G-9.14

22
23

T-9.3
G-9.15

Description
Market share of major brokerage firm
Details of major players
Financial Analysis of DBFS
Financial Ratios of DBFS
List of Selected companies
Option Traded quantity of call option of Axis Bank
Option Traded quantity of call option of ICICI Bank
Option Traded quantity of call option of HDFC
Bank
Option Traded quantity of call option of KOTAK
Bank
Option Traded quantity of call option of HCL
Option Traded quantity of call option of Infosys
Option Traded quantity of call option of TCS
Option Traded quantity of call option of Wipro
Option Traded quantity of call option of Dr.Reddy
Option Traded quantity of call option of Cipla
Option Traded quantity of call option of SunPharma
Option Traded quantity of call option of Lupin
Anova table For banks
Movement of difference in calculated and actual
value on different date for each bank comapny
Anova Table for ITs
Movement of difference in calculated and actual
value on different date for each IT company
Anova Table for Pharmaceuticals
Movement of difference in calculated and actual
value on different date for each Pharma company

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9
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Industry Analysis
The Indian broking industry has evolved in a rapid speed in the last decade
and has undergone a significant paradigm shift. This industry has shown most of the
negative trapping but now is being considered as a preferred sector for careers
irrespective of disciplines. This industry majorly depends upon the number of
participants in Stock market, traded volume, and the type of fluctuations. Growing
participation by investors spread beyond the traditional geographical pockets,
coupled with professionalization of work cultures and demand for value-added
services like investment advisory and portfolio management, has created a huge
demand for talent at all levels.
From the ancient times, Bank sector has always dominated on Indian
financial services. However, globalization & liberalization of Indian Equity Markets
has led to rapid modernization and the professionalization of the financial sector. In
addition, this led to the emergence of the broking industry, as core and important
part of financial services sector, competing for talent with banks, insurance
companies. The Indian Broking industry is now attracting more of the foreign
investors to hedge and maintain their assets and funds. This industry is not only
attracting the big players to invest but also small players who want to make good
return but with risk.
The Indian broking industry is characterized by a huge number of companies
,private or unorganized, now a days. This industry is a fragmented industry with a
large number of participants. The industry thus has monopolistic competition a large
number of firms selling a slightly differentiated product. Although there are more
than 9000 brokers registered with SEBI 80% of the turnover in NSE and BSE is
accounted by about 100 brokers
The total trading volume of the Indian brokerage companies stood at US$
1239.1 billion in the year 2004, which increased to US$ 1492.1 billion in 2005. It is
further expected to reach US$ 6535.7 billion by the year 2015.

Key Features of the Industry


Stock market development in India was that that it was entirely driven by
local enterprise, and later on, many big companies found the opportunity and
invested in this sector. Many a factor makes this Industry lucrative.
Low Barriers to entry:
In pre-2008, there was a very few formalities to open a brokerage firm but
now a days this has certain level of entry barriers. It requires having a certain scale
and size as the business involves a high level of fixed costs in the form of

technology platform, distribution network and back office operations. In addition,


brand recognition is also important to attract new customers.

A commission-based remuneration structure:


Brokerage firm earn money through payment of commissions. In this
industry , broking firm will earn money on each transaction, irrespective of clients
profit/loss status. This industry is sort of risk free industry where the company will
make profit, either the market goes up or goes down.
Bargaining power of customer:
Many retail investors often lack the knowledge and expertise in the financial
sector that calls them to approach the broking houses. The low Product
differentiation proves beneficial for the customers. The retail broking services
provided by the various companies is homogeneous with very low product
differentiation. This allows customers to enjoy a greater bargaining power.

Online Trading System:


Almost all the brokerage firms are now providing online features to their
clients. It has been the essential feature of any brokerage firm that how smoothly
they are providing the technical facility. Many smaller brokerage firms have taken
control of most individual investors accounts. They are continuously adding
convenience and personal attention to the small investor.

Full-Service and Discount Commissions:


The traditional brokerage firms are working on Full-Service commission
base service. They have good experience about the market that is why they provide
good tips and information, and against this, the client pays a full service charge.
Now the scenario is changing, many a brokers are coming out with discounted
commission. They do not provide any tips but the commission charge is far below
than
full-service
charge.

Major Players
Below is the list of listed companies in NSE/BSE and their share according
to market cap.

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Market Cap. (Rs. cr.)


Others; 2008
Geojit BNP; 544Network 18; 3610
Kirloskar Broth; 582
Pilani Invest; 1057
Edelweiss Fin; 2292
Capital First; 1105
India Infoline; 1786
Motilal Oswal F; 1194
SKS Microfin; 1415
Delta Corp; 1623

Network 18

Edelweiss Fin

India Infoline

Delta Corp

SKS Microfin

Motilal Oswal F

Capital First

Pilani Invest

Kirloskar Broth

Geojit BNP

Others

Graph G-1.1 (Source: www.moneycontrol.com)


Although, many of the good brokerage companies are not listed and they are
working as a private firm. Below is the list of top 13 best and the most popular
brokerage firm providing best and reliable services. This list is on the basis of survey
of investor and trader of many clients.
Terminal
s
4320
1700
5715
173
2876
2428

Sub
Brokers
910
19000
NA
173
NA
1494

No
of No
of
Employees
Branches
4008
350
3910
581
284
NA
NA
605
5873
522
2037
142

Name
Kotak Securities ltd
ShareKhan ltd
Angel Broking ltd
India Infoline ltd
Indiabulls
Reliance Money
Motilal
Oswal
Securities
7923
890
2193
63
Geojit BNP Paribas
627
247
343
314
Karvy Stock Broking
ltd
NA
NA
NA
NA
Bonanza Onlline
NA
NA
NA
NA
HDFC Securities
NA
NA
NA
NA
Anand Rathi Securities
Ltd
1527
320
4566
220
NA:Data not available
Table T- 1.1
Source:(http://www.sharegyaan.com/tips-ideas/top-15-best-most-popular-brokingfirms-in-india/)

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Five Years Trend


This industry has emerged as an attractive industry in the last decade only.
Before it, it was present there but due to the lack of technology and support from
government, it did not grow as much fast as it has capability.
India Brokerage Industry- Pre 2000

It was known as Mom and Pop shop only.


People invested only in Friends and Relatives Business Company.
There was no derivative trading.
Low trade volumes.
Lack of technology.
Settlement was T+15 days.

India Brokerage Industry- 2000-2008


Venture capitalist started investing in Brokerage business
Huge investment in technology
National presence.
Traded volume increased drastically
A higher volume of derivatives being traded.
Margin funds for the retail client.
Indian Brokerage Industry post 2008
Global risk aversion is unwinding and Confidence levels returning,
being reflected in performance of the indices
Liquidity and credit flows improving
Political stability and India re-rating
FII and Domestic Flows resuming

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Company Analysis
Mission
We are committed to create and enhance wealth for corporate and retail
customers, by delivering cutting-edge financial solutions which suit their specific
needs.
Vision
We want to remain as the leading, trusted total financial services provider,
wherever we operate, by maintaining superior technological and service standards,
and by keeping trust and transparency as our core values.
Organization Structure
The company operates regionally and below is the regions in which it
operates.
Kerala South
Kerala North
Bangalore
Chennai
Mumbai
Hyderabad.
All above regions have the Regional Manager and the Branch Managers for
each branch within that region. There are more than 300 employees in the
franchisees, but these franchisees are only associated with DBFS. They are not
directly related with the company organization structure. They work like
independent small business associate who registered themselves with DBFS to get
sub brokerage license.
The details of the Organization structure are given on next page.

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14

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HR Details No. of employees


In DBFS, there are employees are 250-300 in entire DBFS in India. The head
offices Kochin have 100 employees and all 6 regions have 30-40 employees each. In
Our Bangalore (Castle street branch) regional office branch, there are 6 employees
and a Regional Manager.
Product and Services
DBFS offers a complete life-cycle of investment solution in Equities,
Derivatives, Commodities, IPO, Mutual Funds, Depository Services, and Insurance.
In the contemporary world, online internet trading has given an enormous space for
a wide range of possibilities. The company is diversified in several types of product
and services. Below are some services.

Commodities and Forex Trading in DGCX:

DGCX is an initiative of the Dubai Multi Commodities Centre (DMCC),


Financial Technologies (India) Limited and the Multi Commodity Exchange of
India Limited (MCX). The Management team of DGCX comprises senior
personnel from the commodities, securities and financial services industries
bringing a wealth of experience and expertise to ensure the success of DGCX.
DBFS offers DGCX
As a trading member of DGCX, Dubai, DBFS Commodities DMCC offers
trading in commodities and forex for its customers.

Benefits of Trading on DGCX


Our range of futures contracts offers participants of the physical
commodities markets, such as producers, manufacturers and end users, with a
sophisticated means of hedging their price risk exposure. Such price risk
management has previously been unavailable to producers in the Middle East. In
addition, DGCX offers trading opportunities to financial communities and
investment houses in both the Middle East and around the globe who wish to access
the growing asset class of commodity and currency derivatives.

Commodities Futures Trading


The group has membership in all premier commodity exchanges in India,
namely NCDEX, NMCE and MCX. The company facilitates futures trading for
various agricultural commodities and other commodities including crude oil, gold,
silver, rubber, cardamom, pepper etc. which are actively traded.

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Depository Participant
DBFS Securities Ltd. is a Depository Participant with Central Depository
Services Ltd. (CDSL). CDSL is one of only two depositories in India for electronic
holding of securities. The Company extends depository services to its trading
clients as well as non-trading clients. The custodial services include electronic
holding of securities, Demat, Remat, pledge, unpledge etc. and market and offmarket transfers, transmission, transposition etc.

Mutual Funds & Insurance


DBFS, being a total solutions provider for the varied investment needs of
the retail investors, distributes Mutual Fund products of almost all major AMCs.
Application Forms of NFOs are available with the branches.DBFS does distribute
the Life products of TATA Aig and Non-Life products of Reliance Insurance

Portfolio Management
DBFL Ltd. is a SEBI registered Portfolio Manager with an excellent track
record of performance. The group has a highly professional, experienced and resultoriented research team which analyzes the markets and manages the customers
funds accordingly in order to ensure optimum results. DBFS Portfolio Managers
consistently out-performs the bench-mark indices.

Trading in Equities
DBFS has membership in both NSE and BSE, MCX. The group has been
permitted to operate in the cash as well as derivative segments of NSE and BSE.
Online trading in Cash Market and FAO are available at all the branches.
Connectivity is provided at the Branches by way of VPN / Broad Band. The group
services both retail and institutional customers.

Customers
DBFS serves mainly individual customers, HUF (Hindu undivided family).
It also serves many public listed companies and a few private venture firms.
Competitors
DBFS is mainly present in South India and here the main competitors of
DBFS are:
Geojit Securities
JRG Securities
Hedge Equities
Share wealth Securities
Cap stocks India Pvt. Ltd

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Basic financial Analysis


BALANCE SHEET AS AT MARCH
31, 2012
Amount in Rs.
31st
March
2012
31st March 2011
Liabilities
64,066
63,393
SHAREHOLDERS FUNDS
,389
,608
SHARE
APPLICATION
MONEY
43,999
PENDING ALLOTMENT
,985
2,872
DEFERRED TAX LIABILITIES (NET)
,295
3,363,536
44
508,70
LONG TERM PROVISIONS
7,274
8
164,968,
CURRENT LIABILITIES
344
156,923,360
276,354,
Total

287

224,189,212

Assets
FIXED ASSETS
16,763
(i) TANGIBLE ASSETS

,630

16,006
,162

47,976
(ii) INTANGIBLE ASSETS

,260

43,735
,926

211,614,
CURRENT ASSETS

397

164,447,
124

276,354,
TOTAL

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287

224,189,
212

Profit and Loss account AS AT


MARCH 31, 2012

REVENUE FROM OPERATIONS

II

OTHER INCOME

Amount in Rs.
31st March
2012
101,800,
499
21,724
,151
123,524,
650
122,190,
095

31st March
2011
135,782,
195
21,773
,354
157,555,
549
144,071,
983

1,334

13,483

III TOTAL REVENUE (I + II)


I
V TOTAL EXPENSES
PROFIT BEFORE EXCEPTIONAL
AND EXTRA ORDINARY ITEMS &
TAX (III-IV)
,555
EXCEPTIONAL ITEMS

,566
16

Current Tax

3,630

2,726
,897

7
Deferred Tax

2,565

1,129
,243

98
Short provision of tax of previous year
9,386
PROFIT FOR THE PERIOD FROM
CONTINUING OPERATIONS
8,974

10

9,627
,426

10

9,627

Balance Carried to Balance Sheet


EARNINGS PER EQUITY SHARE:

8,974

,426

Basic

0.02

1.67

Diluted

0.02

1.67

Table T-2.1

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Ratios:
Ratio
Debt-Equity ratio
Current Ratio
Net Profit Margin ratio
Gross Profit Margin ratio
Asset Turnover ratio
Return on Equity
Table 2.2

Value
0.0070
1.2800
0.0012
0.0130
0.3700
0.0017

Operational Processes
Operational process as per the customer point of view that how the whole
transaction gets completed. It is described in below steps:

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The Customers who are interested in trade, they need to be registered clients
of this company.
In order to become a registered member, client has to fill a KYC form which
is mandatory by (SEBI)
After verification the client will be registered as a client of DBFS
After registration, client will get a client ID that will be a unique ID and client
is now ready to any sort of transaction (i.e. equity, commodity, forex,
derivatives etc.)
Clients can update their DBFS account by providing cheque, DD or they can
do online transfer.

Introduction of the Project


The Financial industry has always been a speculative industry. People always
try to invest money, which give them higher returns. In the hope of higher returns,
they also try to take higher risk. Some of the instrument which used to hedge and
invest money is called Derivatives. Financial derivatives are financial instruments
whose prices are derived from the prices of other financial instruments. The
components are Forwards, Futures, and Swaps. Option is also one of the
components in financial derivatives. In the global capital markets of today,
derivatives occupy an integral part of the economy, and are virtually driving the
world markets with the introduction of derivatives trading in the form of futures and
options, the Indian capital market too is witnessing a qualitative change. While
option trading is not new in the country, the growth in option trading has been
accompanied by a tremendous interest among academics and practitioners in the
valuing of option contracts.
In this project, our study will be concentrated towards pricing of Options in
NSE and specifically with the help of Black Scholes formula. We will discuss here
call options for stocks only. three industries i.e. Banks, IT and Pharmaceuticals are
selected randomly . The companies from each industry have been picked up from
Nifty-Fifty as the maximum market share companies. The analysis was done in the
month of April when most of the companys quarterly results were coming out. So
there was much fluctuation in the option price. For the strike price, it was set at
random basis after seeing the fluctuation in share price of that script.
Below companies has been selected based on maximum market share from
Nifty-Fifty.
Name
Axis Bank Ltd.
HDFC Bank Ltd.
ICICI Bank Ltd.
Kotak Mahindra
HCL Technologies Ltd.
Infosys Technologies Ltd.
Tata Consultancy Services Ltd.
WIPRO
Dr. Reddy's Laboratories Ltd.
Cipla Ltd.
Sun Pharmaceutical Industries Ltd.
Lupin

Sector
BANKS
BANKS
BANKS
BANKS
COMPUTERS - SOFTWARE
COMPUTERS - SOFTWARE
COMPUTERS - SOFTWARE
COMPUTERS - SOFTWARE
PHARMACEUTICALS
PHARMACEUTICALS
PHARMACEUTICALS
PHARMACEUTICALS

Table T-2.3

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Objectives of the study


a) Application of Black-Scholes formula: To apply Black Schole model to
calculate the price of options for the given strike rate and given date.
b) Factors affecting the price: What all factors have affected the variation in
call price from the calculated one.
c) Variation (fluctuation) in option price within the industry: For an
industry, calculate whether the price variation is similar for all companies
within the industry or not

Literature Review:
Many of the paper have been already published regarding the pricing of options
using the Black-Scholes formula. The major problem is always considered as volatility of
stock. The stochastic nature of the volatility of most of the financial asset is responsible for
much of the difficulty. The early test of Black-Scholes (1973) option pricing model rely
upon historical prices for volatility estimates and Latane & rendlemans implied volatility
technique has become the standard method of estimation. Later on Beckers (1981) stresses
that it is inconsistent to use the Black-Scholes model with a constant variance to obtain
estimates of ninstationalry variances.
The work conducted by Hull and White (1987) and Johnson and Shanno (1987) has
been directed at solving the problem of pricing European calls on assets with stochastic
volatilities. Hull and White provide a series solution for the case in which the variance and
stock price are uncorrelated, convergence is slow unless the variance of the assets' volatility
is relatively small. For more general cases, both Hull and White and Johnson and Shanno
rely upon Monte Carlo simulations to estimate option prices. The Monte Carlo method tends
to be expensive and is often too time consuming for real-time applications.
Before introduction of spreadsheet programs, Cox and Rubinstein (1985) showed
how to create a simple 2-D table for easy calculation of Blacl-Scholes European call values.
Tom Arnold, Terry and Richard again showed in their paper that option pricing tables
described in Cox and Rubinstein still have tremendous pedagogical value.

In 2008 letter to Berkshire shareholders, Warren Buffett criticized the BlackScholes option pricing model arguing that it can produce "absurd" values for long-dated put
options. Though Mr. Buffett did not explicitiy say so, a careful analysis of his viewpoint

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reveals that his criticism boils down to the belief that future nominal stock prices are not
well approximated by a lognormal distribution with volatility estimated from historical data.
Instead, Mr. Buffett apparently believes that inflationary policies of governments and central
banks will limit future declines in nominal stock prices compared with those predicted by a
historically estimated lognormal distribution. If Mr. Buffett is correct on this point, the
Black-Scholes model will indeed significantly overvalue long-dated put options.

Despite their popularity and wide spread use, the model is built on some nonreal life assumptions about the market. Some assumptions are described as below:
a) Volatility - a measure of how much a stock can be expected to move in the near
term - is a constant over time. Volatility can be relatively constant in very short term
but it is never constant in longer term. Large price changes tend to be followed by large
price changes, and vice versa leading to a property called volatility clustering. Measures
of volatilities are negatively correlated with asset price returns, while trading volumes or
the number of trades are positively correlated, hence volatility cannot be a constant over
time.
b) People cannot consistently predict the direction of the market or an individual
stock. It assumes stocks move in a manner referred to as a random walk. Random walk
means that at any given moment in time, the price of the underlying stock can go up or
down with the same probability. This is usually not true as stock prices are determined
by many economic factors that cannot be assigned the same probability in the way they
will affect the movement of stock prices.
c) Returns of log normally distributed underlying stock prices are normally
distributed. This assumption is reasonable in the real world, though not fitting observed
financial data accurately.
d)

Interest rates are constant and known, just same like with the volatility. It uses the
risk-free rate to represent this constant and known rate. In the real world, there is no
such thing as a risk-free rate, but it is possible to use the Indian Government T-Bills 90day rate since the Indian government is deemed to be credible enough. However, these
treasury rates can change in times of increased volatility.

e) The underlying stock does not pay dividends during the option's life. In the real
world, most companies pay dividends to their shareholders. The basic Black-Scholes
model was later adjusted for dividends, so there is a workaround for this. This
assumption relates to the basic Black- Scholes formula. A common way of adjusting the

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Black-Scholes model for dividends is to subtract the discounted value of a future


dividend from the stock price.
f) No commissions and transaction costs. The model assumes that there are no fees for
buying and selling options and stocks and no barriers to trading. Usually not true as
stock brokers charge rates based on spreads and other criteria.
g) Markets are perfectly liquid and it is possible to purchase or sell any amount of
stock or options or their fractions at any given time. This again is not plausible as
investors are limited by the amount of money they can invest, policies of their
companies and by the wish of sellers to sell. It may not be possible to sell fractions of
options as well

Hypothesis Development
H0: There is difference between observed and calculated value of option price.
H1: There is difference with Share price and difference between observed and
calculated values i.e. The fluctuation (difference between observed and calculated
values) has same variation within the industry.

Research Methodology:
In this section, information about data, tools used to analyze that data and the
methods to interpret those data is mentioned.
Data:
Data Type:
Almost all the data used in this project is secondary data. The price of shares is taken
from the NSE website. From the same website, prices of call options are also taken
for a specific exercise price and expiry date.
Data Source:
The analysis of this project is done at office of Doha Brokerage Financial Services.
But the data used for analysis is taken from the NSE website.

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Data Tenure:
For the analysis purpose, last one year data of all 12 companies has been taken from
NSE.

Analysis Tools:
Black-Scholes Formula: The Black-Scholes model is used to calculate the
theoretical price of European put and call options, ignoring any dividends paid
during the option's lifetime. This model has some limitation as follows:

The options are European and can only be exercised at expiration


No dividends are paid out during the life of the option
Efficient markets (i.e., market movements cannot be predicted)

No commissions
The risk-free rate and volatility of the underlying are known and constant
Follows a lognormal distribution; that is, returns on the underlying are
normally distributed.

To apply this formula, Black-Scholes takes following variable into consideration.

Current underlying price


Options strike price
Time until expiration, expressed as a percent of a year
Implied volatility
Risk-free interest rates

Chi Square formula: Chi-square is a statistical test commonly used to compare


observed data with data we would expect to obtain according to a specific
hypothesis. The chi-square test is always testing what scientists call the null
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hypothesis, which states that there is no significant difference between the expected
and observed result.
The formula for calculating chi-square is:

2=(oe )2/e
That is, chi-square is the sum of the squared difference between observed (o) and the
expected (e) data (or the deviation, d), divided by the expected data in all possible
categories.
Step-by-Step Procedure for Testing Your Hypothesis and Calculating Chi-Square
1. State the hypothesis being tested and the predicted results.
2. Determine the expected numbers for each observational class. Remember to use
numbers, not percentages.
3. Calculate 2 using the formula. Complete all calculations to three significant
digits. Round off your answer to two significant digits.
4. Use the chi-square distribution table to determine significance of the value.
5. State your conclusion in terms of your hypothesis.
a) If the p value for the calculated 2 is p > 0.05, accept your hypothesis.
b) If the p value for the calculated 2 is p < 0.05, reject your hypothesis, and
conclude that some factor other than chance is operating for the deviation to
be so great.
ANOVA (ANalysis Of VAriance): This tool performs a simple analysis of variance
on data for two or more samples. The analysis provides a test of the hypothesis that
each sample is drawn from the same underlying probability distribution against the
alternative hypothesis that underlying probability distributions are not the same for
all samples.
Method :
The first task in this project is to apply Black Scholes model to calculate the
price of options for the given strike rate and given date. After calculating the option
price, this price will be compared with actual value of option that was being traded
on that day and at last for an industry, we have to calculate whether the price
variation is similar for all companies within the industry

26

Steps:
a) The standard deviation of the share price of the company will be calculated
in the basis of last year share price fluctuations.
b) The risk free interest rate has been taken from RBI.
c) Exercise price was selected randomly.
d) The call option price was calculated on each day having different spot prices
for the same script with Black Scholes formula.
e) Get traded call option price for the same script, for same exercise price and
of same expiry date from the NSE historical data.
f) Find out the absolute difference between calculated and actual call option
price.
g) Apply Chi square test whether those difference are significant.
h) If there is significant difference then mention the factor behind the
variations.
i) At last apply Anova on taking samples from each company of the same
industry and find that whether variation in call price was similar or not.

Limitations of the study


1. The Black Scholes model can be applied when the return of underlying asset
is normally distributed.
2. There should not be much macroeconomic changes.
3. If there is huge difference in calculated and actual value of option, it is hard to
decide which factor affected the variation in price.

4. The time period of the study was not sufficient for a comprehensive study.
5. The secondary nature of the data has been a constraint for the study.
6. Different people may interpret the same analysis in different ways.
7. The research could confine only to 12 companies from 3 different industries.

27

Analysis of Data:
Calculation of Call Price and Variation:
Sector: Bank
Axis Bank (NSE: AXISBANK):
Date: 23th April
Spot Price: Rs. 1444.80
Exercise Price: Rs. 1400
Intrinsic value: Rs. 44.80
Call Price (Calculated)
Call Price (Actual)
Time value (Calculated)
Time value (Actual)

46.361
7
51.85
1.56170
3
7.05

From the data table of Axis Bank, Call price (at exercise price: 1400) is varying too
much form the expected value in the entire month.
Chi-square Probability = 1.052 % < 5%
accept the Hypothesis H0.
Reason: Investors were also expecting good quarter result and because of that the
demand of call options was high. All the news was in favour of Axis Company
which led to the high rate of call price.
Below table deppicts the no of traded contract in this entire month.

28

No of Contracts

Option Traded Quantity

2500
2000
1500
1000
500
0
1-Apr-13

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Graph 9.1

29

ICICI Bank (NSE: ICICIBANK):


Date: 23th April
Spot Price: Rs. 1161.30
Exercise Price: Rs. 1150
Intrinsic value: Rs. 11.30
Call Price (Calculated)
Call Price (Actual)

16.20
20.65

Time value (Calculated)


Time value (Actual)

4.90
9.35

From the data table of ICICI Bank, Call price (at exercise price: 1150) is varying too
much form the expected value.
Chi-square Probability = 0 % < 5%
accept the Hypothesis H0.
Reason: Investors were also expecting good quarter result and because of that the
demand of call options was high. All the news was in favour of ICICI Company
which led to the high rate of call price.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

5000
4000
3000
2000
1000
0
1-Apr-13

Graph 9.2

30

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

HDFC Bank (NSE: HDFCBANK):


Date: 23th April
Spot Price: Rs. 689
Exercise Price: Rs. 650
Intrinsic value: Rs. 39
Call Price (Calculated)
Call Price (Actual)

39.30
41.6

Time value (Calculated)


Time value (Actual)

0.30
2.6

From the data table of HDFC Bank, Call price (at exercise price: 650) is not varying
too much form the expected value for the entire month period.
Chi-square Probability = 18 % > 5%
Reject the Hypothesis H0. The variation is only by chance not only due to any
factor.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

200
150
100
50
0
1-Apr-13

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Graph 9.3

31

KOTAK Bank (NSE: KOTAKBANK):


Date: 23th April
Spot Price: Rs. 691.9
Exercise Price: Rs. 660
Intrinsic value: Rs. 31.9
Call Price (Calculated)
Call Price (Actual)

32.22
31.55

Time value (Calculated)


Time value (Actual)

0.32
-0.35

From the data table of KOTAK Bank, Call price (at exercise price: 660) is varying
too much form the expected value.
Chi-square Probability = 91 % > 5%
Reject the Hypothesis H0. The variation is only by chance not only due to any
factor.
Below table depicts the no of traded contracts in the entire month.
No of Contracts

Option Traded Quantity

50
40
30
20
10
0
1-Apr-13

Graph 9.4

32

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Sector: IT
HCL (NSE: HCLTECH):
Date: 16th April
Spot Price: Rs. 762
Exercise Price: Rs. 800
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)

1.66
16.15

Time value (Calculated)


Time value (Actual)

1.66
16.15

From the data table of HCL , Call price (at exercise price: 800) is varying too much
form the expected value for few dates.
Chi-square Probability = 0 % < 5%
accept the Hypothesis H0.
Reason: Investors were also expecting good quarter result and because of that the
demand of call options was high. All the news was in favour of HCL Company
which led to the high rate of call price but later on there was reduction in price due
to actual quarter result.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

5000
4000
3000
2000
1000
0
1-Apr-13

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Graph 9.5

33

INFOSYS (NSE: INFY):


Date: 11th April
Spot Price: Rs. 2916.7
Exercise Price: Rs. 2950
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)

Time value (Calculated)


Time value (Actual)

57.07
8
116.0
5
57.078
116.05

From the data table of INFOSYS, Call price (at exercise price: 2950) is varying too
much form the expected value for most of dates.
Chi-square Probability = 0 % < 5%
accept the Hypothesis H0.
Reason: The price of infy script was increasing at a very high rate and investors has
lot of faith in this company which led to shoot up the call price.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

8000
6000
4000
2000
0
1-Apr-13

Graph 9.6

34

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

TCS (NSE: TCS):


Date: 15th April
Spot Price: Rs. 1472.45
Exercise Price: Rs. 1600
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)
Time value (Calculated)
Time value (Actual)

0.49678
8
18.85
0.49678
8
18.85

From the data table of TCS, Call price (at exercise price: 1600) is varying too much
form the expected value for all the dates.
Chi-square Probability = 0 % < 5%
accept the Hypothesis H0.
Reason: Few of the news before 16th April, actually led to the higher call price and
people were expecting good result this time, But later on there was drastic
movement in call price and TCS shares fall suddenly which also reflected in call
price.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

5000
4000
3000
2000
1000
0
1-Apr-13

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Graph 9.7

35

WIPRO (NSE: WIPRO):


Date: 8th April
Spot Price: Rs. 448.80
Exercise Price: Rs. 450
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)
Time value (Calculated)
Time value (Actual)

10.0504
4
0.6
10.0504
4
0.6

From the data table of WIPRO, Call price (at exercise price: 450) was not varying
too much but it was deviating more form the expected value for all the dates.
Chi-square Probability = 0 % < 5%
accept the Hypothesis H0.
Reason: Investors were very bearish on this stock and very little trade happen for
this script. There was no demand for this call option so the price fell down.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

50
40
30
20
10
0
1-Apr-13

Graph 9.8

36

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Sector: Pharmaceuticals
Dr. Reddy (NSE: DRREDDY):
Date: 15th April
Spot Price: Rs. 1852.65
Exercise Price: Rs. 1900
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)

7.14
15.85

Time value (Calculated)


Time value (Actual)

7.14
15.85

From the data table of DrREDDY, in 1 st week of April the call price (at exercise
price: 1900) did not deviate from the expected value but after 1 st week there was
much difference between expected and calculated value.
Chi-square Probability = 2 % < 5%
accept the Hypothesis H0.
Reason: Although the quarter 4 result was going to announce in May but investors
were expecting a positive growth in stock of Dr. Reddy.
Below table depicts the no of traded contracts in the entire month.
No of Contracts

Option Traded Quantity

250
200
150
100
50
0
1-Apr-13

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Graph 9.9

37

CIPLA (NSE: CIPLA):


Date: 18th April
Spot Price: Rs. 401.15
Exercise Price: Rs. 400
Intrinsic value: Rs. 1.15
Call Price (Calculated)
Call Price (Actual)

5.93
5.7

Time value (Calculated)


Time value (Actual)

4.78
4.55

From the data table of CIPLA, the call price (at exercise price: 400) did not deviate
from the expected value .
Chi-square Probability = 99 % > 5%
Reject the Hypothesis H0. The little bit variation is only due to chance.
Reason: the Q4 result was suppose to come in May and due to very few news
regarding Cipla, It did not show fluctuation as other script showed.
Below table depicts the no of traded contracts in the entire month.
No of Contracts

Option Traded Quantity

600
500
400
300
200
100
0
1-Apr-13

Graph 9.10

38

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

SUN PHARMA (NSE: SUNPHARMA):


Date: 15th April
Spot Price: Rs. 873
Exercise Price: Rs. 900
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)

2.92
6.1

Time value (Calculated)


Time value (Actual)

2.92
6.1

From the data table of Sun Pharma, in 1st and 2nd week the call price (at exercise
price: 900) deviated much from the expected value .
Chi-square Probability = 2 % < 5%
Accept the Hypothesis H0.
Reason: The Q4 result was about to come in last week of April so some the
investors showed interest in this script but after 2 nd week investors did not show
much interest in this script.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

400
300
200
100
0
1-Apr-13

6-Apr-13

11-Apr-13

16-Apr-13

21-Apr-13

26-Apr-13

Graph 9.11

39

LUPIN (NSE: LUPIN):


Date: 15th April
Spot Price: Rs. 657.45
Exercise Price: Rs. 660
Intrinsic value: Rs. 0
Call Price (Calculated)
Call Price (Actual)
Time value (Calculated)
Time value (Actual)

9.020422
3
10.15
9.020422
3
10.15

From the data table of LUPIN, the call price (at exercise price: 660) did not deviate
from the expected value much .
Chi-square Probability = 32 % > 5%
Reject the Hypothesis H0. The little bit variation is only due to chance.
Reason: the Q4 result was supposed to come in May and due to very few news
regarding LUPIN, It did not show fluctuation as other script showed.
Below table depicts the no of traded contracts in the entire month.

No of Contracts

Option Traded Quantity

5000
4000
3000
2000
1000
0
27-Mar-13 1-Apr-13 6-Apr-13 11-Apr-13 16-Apr-13 21-Apr-13 26-Apr-13 1-May-13

Graph 9.12

40

Analysis of Companies within the Industry:


Sector: Banks
Application of One-way Anova to measure the means of each company deviation.
Anova: Single
Factor
SUMMARY
Groups

Count

AXIS

16

ICICI

16

HDFC

16

KOTAK

16

Sum
37.935
12
22.371
87
33.238
77
15.017
91

SS

df

20.21310
155.1449
7

ANOVA
Source
Variation
Between
Groups
Within
Groups

Averag
e
2.3709
4
1.3982
4
2.0774
2
0.9386
2

Varianc
e
6.4342
8
1.6536
1
0.7916
0
1.4635
0

MS
6.7377
01
2.5857
50

F
2.6057
05

of

Total
Anova: Single
Factor

175.3580
7

60

P-value
0.0599
60

F crit
2.7580
78

63

Table T-9.1
Since F value < F Crit, So Our Hypothesis is correct and we will accept is that there
is relation in between fluctuation in difference of observed & calculated and Share
price of scripts.

41

12
10
AXIS

Linear (AXIS)

ICICI

Differenec in calculated and Observerd price (Rs.) 4

Linear (ICICI)

HDFC

0
21-Apr-13
-2
1-Apr-13

Linear (HDFC)
KOTAK
Linear (KOTAK)

Date

Graph G-9.13
Sector: IT
Application of One-way Anova to measure the means of each company deviation.
Anova: Single
Factor
SUMMARY
Groups

Count

HCL

16

Infy

16

TCS

16

Wipro

ANOVA
Source
Variation
Between
Groups
Within
Groups

16

-1.4531

11.755
2

Average

df

MS
684.5850
5
108.4267
3

4.6608
14.2001

of

Total
Anova: Single
Factor

42

8.0806

Varianc
e
17.247
6
362.59
79
42.106
3

Sum
74.573
2
227.20
22
129.28
93
23.250
0

SS
2053.755
2
6505.604
0
8559.359
2

3
60

63

F
6.3138
0

Pvalue
0.0008
6

F crit
2.7580
8

Table T-9.2
Since F value > F Crit, So our hypothesis H1 is wrong and we will reject the
hypothesis. So there is no relation in between fluctuation in difference of observed
& calculated and Share price of scripts.
70
60

sDifferenec in calculated and Observ erd price (Rs.)

50

HCL

40

Linear (HCL)
Infy

30

Linear (Infy)

20

TCS

10

Linear (TCS)

0
1-Apr-13
-10

21-Apr-13

Wipro
Linear (Wipro)

Date

Graph G-9.14
Sector: Pharma
Application of One-way Anova to measure the means of each company deviation.
Anova: Single
Factor
SUMMARY
Groups

Count

Dr Reddy

16

Cipla

16

SunpPharma

16

Lupin

16

Sum
61.431
08
10.584
11
30.921
54
17.246
63

SS

df

95.52366
305.8328

3
60

ANOVA
Source
Variation
Between
Groups
Within

Averag
e
3.8394
4
0.6615
1
1.9326
0
1.0779
1

Varianc
e
12.087
00
0.4021
2
2.1265
3
5.7732
1

MS
31.841
22
5.0972

F
6.2467
9

of
P-value
0.0009
2

F crit
2.7580
8

43

Groups

Total
Anova: Single
Factor

401.3566

1
63

Table T-9.3
Since F value > F Crit, So our hypothesis H1 is wrong and we will reject the
hypothesis. So there is no relation in between fluctuation in difference of observed
& calculated and Share price of scripts.
13
11
9
7
5
3

Dr Reddy

Cipla

SunpPharma

Lupin

1
-1
31-Mar-13

5-Apr-13

10-Apr-13

15-Apr-13

20-Apr-13

-3
-5

Graph G-9.15

Findings and Conclusions


Volatility in Price of Script:
Price volatility plays an important role to the change in price of options. It
fluctuates dramatically while changing in script price.

Psychology of Indian Market:


The news played a very significant role while pricing the call price in NSE.
Indian traders are very emotional, they extremely believe on news only not the
fundamental analysis. The moment any news came there was too much variation
in the call price.

Traded Volume of Option Contracts:

44

The trends showed that no of contracts traded were highest when they were near
to expiry date.

Difficult to determine the actual factors behind the variation in prices


No factors can be determined that which led to the change in variation of call
price. The major roles were played either by the quarter result of the company or
the news or the report from any of the analyst.
Difference between calculated and actual price, varies much from sector to
sector.

45

Suggestions
Time Period of Analysis
The time period of analysis should lie in between July to December. This period
is known as stagnant period. During this period RBI is very unlikely to change
the interest rate, the annual result of most of the company also did not fall in to
this period etc. So no macroeconomic factors play any role in fluctuation of
market/ script trend.

Duration of Analysis:
The duration must be at least 4-6 month to get the proper result from the BlackScholes formula.

Picking up the script for analysis


The Black-Scholes formula is suitable for those scripts of which returns are
normally distributed. It is advisable to check the returns of the script before
picking for the analysis.

Volatility measurement
The measures of volatilities are negatively correlated with asset price returns ,
while trading volumes or the number of trades are positively correlated, hence
volatility cannot be a constant over time. Some of the advanced option valuation
models substitute Black-Scholes's constant volatility with stochastic process
generated estimates.

46

Bibliography
www.nseindia.com
www.dbfsindia.com
www.search.ebscohost.com
www.jstor.org
www.sebi.gov.in
www.teachexcel.com
www.indiaonline.in
www.bseindia.com
Arnold, Tom; Nixon, Terry D.; Shockley, Richard L., Jr.; Journal of Applied
Finance, Spring-Summer 2003, v. 13, iss. 1, pp. 46-55.
Cornell, Bradford; Journal of Portfolio Management, Summer 2010, v. 36, iss. 4, pp.
107-11.
Journal of Financial & Quantitative Analysis. Dec89, Vol. 24 Issue 4, p527-532. 6p.
John Adams, Hafiz, Robert and David. Research methods for graduates business and
Social Scinces. Response Publication.
Simon Benninga. Financial Modeling (With CDROM). MIT Press (MA) (2008)
Takada, H.H.; de Oliveira Siqueira, J. In: AIP Conference Proceedings, 2008,
vol.1073, pp. 332-9, Conference Paper in Journal.
Teneng, Dean; International Research Journal of Finance & Economics, 2011.

47

Annexure:

48