Product details

Product details
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Published by: Allied Business Academies
Originally published in: "Journal of International Business Research", 2011
Length: 26 pages

Abstract

One of the most popular derivatives today used in the financial markets are options. The holder (buyer) of an option is allowed to walk away from the contract if market factors should become unfavorable and exercise whenever profitable. Option greeks, or the sensitivity of an option's premium to changes in market factors, are key to successful options trading. Greek parameters on option premium sensitivity to changes in dividend yields have not yet been popularized and its properties have not yet been explored extensively. This paper aims to find a model that will measure the possible change in the stock option's premium whenever the announced dividend yield differ from the one previously paid. This was done by taking the first partial derivative of Merton's extension from the Black-Scholes pricing model of options with respect to the dividend yield variable. The derived changes from this partial derivative were compared to the actual change in the financial markets. In addition, the approximated change using this method was compared to the estimates using the option's delta and the approximated change in the underlying stock. Simple OLS regression and t-tests were used mainly in the analysis and comparison of the variables involved in the study. Using these techniques, it was found that the derived partial derivative proves to be a significant estimator of the change of the option's price. Further, it was also found that this method of approximation has less error when compared to the actual, versus the estimates using the option's delta and the expected change in the underlying stock.

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Abstract

One of the most popular derivatives today used in the financial markets are options. The holder (buyer) of an option is allowed to walk away from the contract if market factors should become unfavorable and exercise whenever profitable. Option greeks, or the sensitivity of an option's premium to changes in market factors, are key to successful options trading. Greek parameters on option premium sensitivity to changes in dividend yields have not yet been popularized and its properties have not yet been explored extensively. This paper aims to find a model that will measure the possible change in the stock option's premium whenever the announced dividend yield differ from the one previously paid. This was done by taking the first partial derivative of Merton's extension from the Black-Scholes pricing model of options with respect to the dividend yield variable. The derived changes from this partial derivative were compared to the actual change in the financial markets. In addition, the approximated change using this method was compared to the estimates using the option's delta and the approximated change in the underlying stock. Simple OLS regression and t-tests were used mainly in the analysis and comparison of the variables involved in the study. Using these techniques, it was found that the derived partial derivative proves to be a significant estimator of the change of the option's price. Further, it was also found that this method of approximation has less error when compared to the actual, versus the estimates using the option's delta and the expected change in the underlying stock.

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