What is the Black-Scholes Model?
Options are a financial instrument giving the holder the right to buy or sell an underlying stock or commodity at a future point in time, at an agreed upon price. The Black-Scholes model, for which Fischer Black, Myron Scholes and Robert Merton were awarded the Nobel Prize in Economics, is a tool for pricing equity options. Prior to its development there was no standard way to price options; in a very real sense, the Black-Scholes model marks the beginning of the modern era of financial derivatives. There are several assumptions underlying the Black-Scholes model. The most significant is that volatility, a measure of how much a stock can be expected to move in the near-term, is a constant over time. The Black-Scholes model also assumes stocks move in a manner referred to as a random walk; at any given moment, they are as likely to move up as they are to move down. By combining these assumptions with the idea that the cost of an option should provide no immediate gain to either seller o
Select Your Language… Translate to Chinese Translate to Spanish Translate to French Translate to German Translate to Italian Translate to Portuguese Black-Scholes Model Introduction The Black-Scholes model is a tool for equity options pricing. Prior to the development of the Black-Scholes Model, there was no standard options pricing method and nobody can put a fair price to charge for derivatives such as stock options. The Black-Scholes Model turned that guessing game into a mathematical science which helped develop the derivatives markets into the lucrative industry it is today. Hence, it is fair to state that the Black-Scholes model ushered the beginning of the modern era of financial derivatives. The price of an option contract derived from an options pricing model such as the Black-Scholes model is known as the “Theoretical Value”. Option traders compare the prevailing option price in the exchange against this theoretical value in order to determine if a particular option contrac
