What is the Black Scholes option pricing model?
The formula, developed by three economists – Fischer Black, Myron Scholes and Robert Merton – is perhaps the world's most well-known options pricing model. The Black-Scholes model makes certain assumptions: The option is European and can only be exercised at expiration.
An option pricing theory is any model or theory-based approach for calculating the fair value of an option. Today, the most commonly used models are the Black-Scholes model and the binomial model.
- A binomial distribution is very different from a normal distribution, and yet if the sample size is large enough, the shapes will be quite similar. The key difference is that a binomial distribution is discrete, not continuous. In other words, it is NOT possible to find a data value between any two data values.
- The Binomial Theorem is a quick way (okay, it's a less slow way) of expanding (or multiplying out) a binomial expression that has been raised to some (generally inconveniently large) power. For instance, the expression (3x – 2)10 would be very painful to multiply out by hand.
- noun. The definition of a trinomial is a math equation that has three terms which are connected by plus or minus notations. An example of trinomial is 6x squared + 3x + 5. Trinomial means the scientific name of a plant. An example of a trinomial is a name which inclues the genus, species and the variety.
Option pricing refers to the amount per share at which an option is traded. Options are derivative contracts that give the holder (the "buyer") the right, but not the obligation, to buy or sell the underlying instrument at an agreed-upon price on or before a specified future date.
- The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. If the employee decides to sell the shares a year after the exercise, the sale will be reported as a long-term capital gain (or loss) and the tax will be reduced.
- An option premium is the income received by an investor who sells or "writes" an option contract to another party. For stock options, the premium is quoted as a dollar amount per share, and most contracts represent the commitment of 100 shares.
- Call options give the holder the right to buy 100 shares of an underlying stock at a specific price, known as the strike price, up until a specified date, known as the expiration date. The market price of the call option is called the premium. It is the price paid for the rights that the call option provides.
Definition. The amount per share that an option buyer pays to the seller. The option premium is primarily affected by the difference between the stock price and the strike price, the time remaining for the option to be exercised, and the volatility of the underlying stock.
- To review, buying a put option gives you the right to sell a given stock at a certain price by a certain time. For that privilege, you pay a premium to the seller ("writer") of the put, who assumes the downside risk and is obligated to buy the stock from you at the predetermined price.
- The Black Scholes model, also known as the Black-Scholes-Merton model, is a model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option.
- Option buyers have the right, but not the obligation, to buy (call) or sell (put) the underlying stock (or futures contract) at a specified price until the 3rd Friday of their expiration month. There are two kinds of options: calls and puts. Put options give you the right to sell the underlying asset.
Updated: 9th October 2018