Academy of Economic Studies of Moldova

Masteral School of Excelence in Economics and Business

The premises and difficulties related to trade of Options in financial markets. Case
Study of Republic of Moldova

Coordinator Rodica Hîncu, Ph.D.

Made by Trifan Dumitru, IPC-121M.
 1.Introduction

Financial markets imply trading of different instruments with different features. The world is
developing, together with financial markets so that more and more sophisticated instruments are
discovered and implemented in practice.

An Option:
- financial derivative instrument
- contract between two parties (seller and buyer)
- offers a future transactional right / obligation on underlying asset

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 2. Theoretical Background

Definition

“In finance, an option is a derivative financial instrument

that specifies a contract between two parties for a future
transaction on an asset at a reference price (the strike)”. (1)
.

Origins
- 332 B.C. First Account of Options (Aristotle's book
named “Politics”) ideea belongs to Thales of Miletus.
- USA, 1872 Russell Sage first OTC Options.
- 1973 - Black–Scholes-Merton model, “The Pricing of Options and Corporate Liabilities.” CBOE was formed
and firstly Call options were introduced.
- 1977, Put options introduced on CBOE

1. Pascucci, Andrea. PDE and Martingale Methods in Option Pricing. Berlin: Springer, 2011.

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 Characteristics

Defined, minimum required parameters:

- The right of the option holder: to buy (a call option) or the right to sell (a put option),
- Quantity and type of the underlying asset(s),
- Strike price (exercise price),
- Expiration date, or expiry, (the last date at which the option can be exercised),
- Settlement terms,
- Market quotation.

Implied parameters:
- the spot price of the underlying asset,
- risk free rate (annual rate, assumed to be continuous compounding),
- volatility of returns of the underlying asset.

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 Valuation Models

Black–Scholes model
The model generates parameters for hedging and risk management of option holdings.

Assumptions:
- No arbitrage opportunity,
- Constant risk-free interest rate,
- It is possible to buy and sell any amount, even fractional, of stock,
- No transaction costs,
- The stock price follows a geometric Brownian motion with constant drift and volatility,
- The underlying security does not pay a dividend.

The Black–Scholes formula calculates the price of European put and call options.

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 Valuation Models

Black–Scholes model
The value of a call option: The value of a put option:

Where:

Notation:

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 Valuation Models
Black–Scholes model
Sensitivity Analysis Greeks:

Exist more 14 greeks that measures also sensitivity of different parameters, and some special
designed greeks for different type of options.

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 Valuation Models

Stochastic volatility models

1987 - Market crash

Option market implied volatility of lower strike prices are typically higher than for
higher strike prices, implying that volatility is stochastic, varying for time and for
the price level of underlying security.

Disadvantage: complex numerical methods (not practical, even with good software).

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 Implementation Models
3 major classes:

- Analytic techniques
Mathematical model => find closed form solutions (Black–Scholes) => computable solutions and sensitivity
parameters.

- Binomial tree pricing model

Dynamics of the option's theoretical value for discrete time intervals over the option's life. Can approximate the
theoretical value calculated by closed form formula, to the desired degree of precision.

- Other models
Based on finite element methods, a so called short rate models, they admit closed-form equations, and
simulation-based modeling.

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 3. Practical issues. Case study

Calculating options
- any method theoretically
- but, need to take into consideration:
= taxation,
= bid-ask market quotes,
= local inflation,
= local market regulations and practices,
= transaction costs,
= settlement and clearing procedures and so on.

Conditions:
- qualified human resources,
- good software and hardware,
- financial resources.

Question: Can a individual investor buy / sell any option ?

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 Options Trade
Market conventions:

Options exchange markets

- Listings and prices are registered and by ticker symbol,

- the publishing is continuous,
- counterparties are anonymous,
- market regulation ensure fairness and transparency.

Over-the-Counter (OTC) markets

- two independent parties,

- unofficial exchange.
- no warranty of exercise.

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 Case Study

Republic of Moldova

-Legal frame - several laws on financial markets and derivative instruments,

-Trading operations are regulated by National Commission for Financial Markets and internal rules of stock exchanges,
-Exchanges for trading options: Moldova Stock Exchange, The Universal Commodity Exchange of Moldova and OTC market,
-Taxation - accordingly to Fiscal Code made by Ministry of Finance of Republic of Moldova.

Posibilities

-Online trade of options,

-European Union integration.

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 Conclusions

Options are financial instruments which are complicated and involve different categories of risks and

qualified resources, in order to deal with them. There exist different categories of options, and new ones

are developed, each of them have their own theoretical background and practical requirements to fulfill.

In general at present time, we assist to a development of these instruments and increase in their use more

in developed countries, but also in developing countries, like Republic of Moldova. However, there are

also situations of markets decline which emphasize the need to develop more these instruments.

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 References
• Options Trading – pedia.com (March 2012) http://www.optiontradingpedia.com/
• Marlow, J. Option Pricing. Published by John Willey and sons. Inc. USA. 2001;
• James, P. Option Theory. The Wiley Finance Series. Published by John Wiley and sons. Inc. USA 2003;
• Rubash, K. Bradley Univeristy. A Study of Option Pricing Models. (March 2012) http://bradley.bradley.edu/
• Investopedia (March 2012) http://www.investopedia.com/
• Chicago Board of Option Exchange (March 2012) http://www.cboe.com/
• Miller, F.P., Vandome, A.F., McBrewster, J. Option. VDM Publishing House Ltd., USA. 2009;
• National Commission for Financial Markets of Republic of Moldova. (April 2013) http://www.cnpf.md/
• Wilmott, P. Derivative, Inginerie Financiară. Teorie şi Practică. Bucureşti. Editura Economică 2002;
• Neftci. S.N. Principles of Financial Engineering. Elsevier Academic Press. USA.2004;
• Hotarire cu privire la aprobarea Regulilor Bursei de Valori Chişinău şi acordarealicenţei pentru dreptul de a desfăşura
activitate profesionistăpe piaţa valorilor mobiliare nr. 2/22 din 12.01.2012;
• Legea cu privire la piaţa valorilor mobiliare nr. 199-XIV din 18.11.98;
• Hotarire cu privire la aprobarea Regulilor Bursei de Valori a Moldovei nr. 62/14 din 26.12.2008;
• Codul fiscal al Republicii Moldova nr. 1163-XIII din 24.04.1997;
• Bursa Universală de Mărfuri a Moldovei (April 2013) http://www.bursa.md/

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Thank you for Attention !

Questions ?

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