Option Boundaries for Equity Option

in India

Presented by
Kunnal Singh 09FN-051
Mahendra Singh Dev 09FN-
054
Paper Studied
 Halpern, P.J. and Turnbull, S.M. (1985) “Empirical tests of
boundary conditions for Toronto stock exchange options.”
Journal of Finance 40(2): 481–500
 Galai, D. (1978) “Empirical tests of boundary conditions for
CBOE options.” Journal of Financial Economics 6: 187–211
 Dixit,Alok and Yadav S.S. (2009)“Violation of lower
boundary condition and market efficiency: An investigation
into the Indian options market.” Journal of derivatives and
hedge funds.
 Sehgal, Sanjay and Vijayakumar, N (2009)“Tests of pricing
efficiency of the Indian index options market.” International
Journal of Business and Society.
“Empirical tests of boundary conditions for
TSE” by Halpern and Turnbull
 Objective: To examine whether call option price obeys
boundary condition thus eliminating arbitrage profits.
 Option & Stock transaction data for the period January 3,
1978 to December 31, 1979 of TSE.
 Dividend Data from TSE Review and the Financial Post
Dividend Record.
 Interest Rate data from Bank of Canada Review .
 For Options with maturities greater than 182, a one year
treasury bill rate was used.
 Exchange rate data were gathered from the Globe and Mail.
Lower Bounds for the Pricing of
Call Options
Lower Bound for an American call options
C{S; T, X) > Max[O, S - X]

If dividend paid dj at calendar time tj j=l,….,n

If dividends over the life of option

 If dividends over the life of option
If dividend paid dj at calendar time tj=l,---,n
Lower Bound for an American call options
Deviation from Boundary Condition
Empirical Test
 If option is priced is rationally ἐ1,2,3 should be non-
positive.
 If any of the ἐ1,2,3 are positive then there is said to
be violation.
 Tests proposed is not valid for testing market
efficiency.
 Test can only indicate whether the option and stock
markets are not synchronized.
Empirical Test Results
Observation
 There tends to be a positive relation between the
maturity of an option & the average dollar size of a
violation.
 The size of the violation tends to be greater for
deep-in-the-money than for in-the-money options.
 The average size of violations tends to increase
with the number of dividend expected to be paid
before the exercise date.
Plan of Action
 Project Title : Option Boundaries for Equity
Option in India.
 Option & Stock transaction data from NSE.
 Interest Rate Used:monthly average yield on 91-
day T-bills converted into a continuously
compounded annual rate of return.
 After Empirical testing we will analyze whether
Option price obeys boundary condition in India.
Thank You