Black-Scholes Stock Option Pricing Model

The Black-Scholes option pricing formula is one of the most popular models for the pricing of equity options. A stock option pricing model attempts to calculate a theoretical fair price for stock options.

The Black-Scholes pricing model takes all of the things that effect the stock options premium in order to calculate a fair price for the said option contract. This particular option pricing model was created in the 70's by Myron Scholes and Fischer Black.

The pricing model they made came to be known as the Black-Scholes option pricing model and is widely used to this very day for European style options.

Myron Scholes went on to win the Nobel peace price in economics. Prior to the Black-Scholes option pricing model, there was really no widely used method to determine the theoretical value of stock option contracts.

Important values known as the Greeks (Delta, Gamma, Theta, Vega and Rho) are related to the formula and are known as sensitivities that can assist a trader or investor to better gauge risk, as well as understand why a particular option price is fluctuating the way it is.

Transparency is key to understanding the relationship between the underlying stock price and its related option contracts.

At the core of the Black-Scholes option pricing model is a complex set of mathematical operations in which uses important information regarding not only the stock price but also fluctuations in volatility and the risk free rate of interest, just to name a few.

The Black-scholes option pricing model shows the fact that an option contract with a longer time until expiration is much more valuable than stock option contracts nearing expiration. This is due to the time decay factor in which all options possess.

Remember, time decay is measured through the option Greek theta.

It is worth noting that the Black-Scholes option pricing model is used for calculating the theoretical value of European style options due to how European options expire.

American options can be exercised at any time. The theoretical value of American style options are calculated using the Binomial option pricing model created by Cox, Ross and Rubenstein in the late 1970's.

A firm grasp regarding the option Greeks is so very valuable to option traders and investors. The Greeks offer transparency into both the stock's and option's premium, as well as the over-all mentality of the market place. Learning Greek sensitivities will give you that much more of an edge in your trading activities.