Black-Scholes Options Pricing Model
Black-Scholes model or Black-Scholes-Merton model was formulated in 1973 by Black, Scholes and Merton. The theory became widely popular and is some extend responsible for the current popularity of the derivates. Black-Scholes model and its variations are still widely used by options traders.
The underlying assumption of the Black-Scholes option price is that the price volatility of the underlying instruments follow a pattern and can be predictable. Thus by incorporating this volatility (implied volatility) value with time to options’ expiration, options’ strike price and time value of money, one can figure out the options price variation. Traders can also calculate the possible volatility if the options price is known. The results are expressed as Options Greeks consisting of Vega, Delta and Theta.
The Black-Scholes options pricing model does not consider the arbitrage of underlying instruments, the taxes and fees involved in trading and earnings from the underlying equity. The model also assumes that the equity is traded often and there is short-selling of it. Although the Black-Scholes model is formulated for European type of options, its variations are available for American type. The main variations of this theory include ARCH, GARCH, N-GRCH, etc
The underlying assumption of the Black-Scholes option price is that the price volatility of the underlying instruments follow a pattern and can be predictable. Thus by incorporating this volatility (implied volatility) value with time to options’ expiration, options’ strike price and time value of money, one can figure out the options price variation. Traders can also calculate the possible volatility if the options price is known. The results are expressed as Options Greeks consisting of Vega, Delta and Theta.
The Black-Scholes options pricing model does not consider the arbitrage of underlying instruments, the taxes and fees involved in trading and earnings from the underlying equity. The model also assumes that the equity is traded often and there is short-selling of it. Although the Black-Scholes model is formulated for European type of options, its variations are available for American type. The main variations of this theory include ARCH, GARCH, N-GRCH, etc
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posted by Daniel Pipitone at
11:48 PM
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