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Black Scholes Model

The Black-Scholes model, developed in 1973 by Myron Scholes and Fischer Black along with Robert Merton, provides a formula for determining the fair price of a call option based on the price of the underlying stock, the strike price, time to expiration, interest rates, and the stock's volatility. The model assumes the stock price follows a random walk with constant drift and volatility, and that markets are efficient, interest rates are constant, and returns are lognormally distributed. The formula calculates the option price as the difference between the expected benefit from acquiring the stock and the present value of paying the exercise price.

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170 views5 pages

Black Scholes Model

The Black-Scholes model, developed in 1973 by Myron Scholes and Fischer Black along with Robert Merton, provides a formula for determining the fair price of a call option based on the price of the underlying stock, the strike price, time to expiration, interest rates, and the stock's volatility. The model assumes the stock price follows a random walk with constant drift and volatility, and that markets are efficient, interest rates are constant, and returns are lognormally distributed. The formula calculates the option price as the difference between the expected benefit from acquiring the stock and the present value of paying the exercise price.

Uploaded by

Anonymous MKcqUbFKrk
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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BLACK SCHOLES MODEL

INTRODUCTION

Developed in 1973

Myron Scholes & Fischer Black

Robert Merton
also participated

Professors at MIT and


University of Chicago

Model
Price

follows amotion with constant drift and


volatility

The

formula takes into consideration the price

of;
Underlyingstock
Strike

priceof the option

Amount

Computers

the use

of time before the option expires

have greatly eased and extended

Formula

Divide the formula into two parts

The first part is SN(d1), derives the


expected benefit from acquiring a stock
outright

This is found by multiplying stock price [S]


by the change in the call premium with
respect to a change in the underlying
stock price [N(d1)]

The second part of the model,


Ke(-rt)N(d2), gives the present value of
paying the exercise price on the expiration
day

The fair market value of the call option is


then calculated by taking the difference
between these two parts.

Assumptions

The stock pays no dividends during the


option's life

European exercise terms are used

Markets are efficient

No commissions are charged

Interest rates remain constant and known

Returns are lognormally distributed

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