fbpx

Black-Scholes Model

The Black-Scholes Model is a mathematical model used to calculate the theoretical price of options. It was developed in 1973 by economists Fischer Black and Myron Scholes, with contributions from Robert Merton. The principles behind the model are rooted in the idea that markets are efficient and that the movement of asset prices can be predicted through a linear, or ‘normal’, distribution.

The entire calculation is built around five primary variables: the current price of the asset, the option’s strike price (the price at which the asset can be bought or sold using the option), the time until the option expires, the risk-free interest rate, and the volatility of the asset. The model assumes constant volatility and interest rates throughout the option’s life. 

While the model may seem complex, its primary purpose is to help investors and traders assess whether an option is overpriced or underpriced. Although it’s widely used and regarded as an integral part of financial theory, the Black-Scholes Model should be used with caution, as its assumptions do not always hold in the real world. Market conditions can change rapidly, and unpredictable events can disrupt the assumed normal distribution of asset prices.

Related Posts

Options Trading

The Covered Call Strategy

DESCRIPTION The covered call is one of the most basic income strategies. But it is so effective that it is used by novices and experts

Read More »

Hedging

Hedging is a risk management strategy used in financial markets to protect against potential losses. It involves making an investment designed to reduce the risk

Read More »

Fear Management

Fear Management is a crucial aspect in the realm of trading psychology. This term refers to the ability to manage one’s fear during trading activities.

Read More »