Pricing of stock options using Black-Scholes, Black's and Binomial Option pricing models

Abstract

Derivative products are very important for developing the financial sector and generating economic growth. Among all the financial derivative products the most commonly used product is Options. Valuation of Options is very crucial in the modern financial industry. Most popular and largely accepted model for pricing options in the modern time is the model given by Black-Scholes. The present study attempts to examine whether the Black-Scholes, Black's and Binomial model is suitable for pricing call options on Indian stocks for five stocks selected from Financial Services Index of NIFTY. Paired samples T-test results indicate that there exists a difference between the calculated prices using the three models and the market prices which is significant for four out of five cases while when the model prices calculated using three models and prices prevailing in the market were compared for HDFC Bank Ltd. stock. No significant difference was found. The three models have effectively priced the call option premium of HDFC Bank Ltd. For all the five call options on stocks it was found that the models have underestimated option premium.