How can we know that there are missprice in option and share price.
How a person can take advantages of this mispricing?
6 Replies
Dhruv
(Chartered Accountant)
(308 Points)
Replied 27 April 2011
For Shares- Either use the Gordon Growth Model ( or the Discounted Dividend Growth Model with 'n' stages) to determine the fair share price and compare it with the existing market price to determine any mispricing. You could also use the Walter model and Asset based valuation methods like the Earnings Capitalization or the NAV Method.
For options- Black Scholes or the Binomial pricing models to value the options.
If you do spot any mispricing, incase of shares, based on the value you've derived and market value, if the value you've derived is lesser than market value then buy, otherwise vice versa.
Incase of options, both call options and put options if they are undervalued ( ie. market price exceeds the price derived from the models), there is an abritrage opportunity. Just go through the options chapter in the any of the SFM reference books, they explain this quite well
Hope this helps!
Princes
(CA Final)
(243 Points)
Replied 27 April 2011
@ Dhruv
My question is that, How can we know that there are missprice in Call option, put option, spot price of share and exercise price.
How a person can take advantages of this mispricing?
CA Nagendra
(CA)
(1788 Points)
Replied 27 April 2011
If Relationship of put call parity does not hold good, then we call that there are mispricing in put, call, current share price and Strike price.
How to take advantages from this mispricing:
(i) If call price in market is less that the fair price of call calcutated using put call parity then
- buy 1 call - Sell 1 put and - Shale 1 share
for Arbitrage gain.
(ii) If Put price in market is less than the fair put price calculated using put call parity then
- Buy 1 put - Sell 1 Call and - Buy 1 share
for arbitrage gain.
I think you got your answer. for more clarity see RTP-May-2011-New syllabus question no-1.
Vivek Himalaya
(Student)
(160 Points)
Replied 28 April 2011
Nagendra sir i need your other notes also please upload it.
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