Location via proxy:   [ UP ]  
[Report a bug]   [Manage cookies]                
Scribd Logo
Upload

Welcome to Scribd!

  • 38 views

    Black Scholes

    Uploaded by

    Aditi
    The Black-Scholes model is a mathematical model for pricing options contracts based on certain assumptions. It assumes the option is European, there are no dividends or transaction costs, and that markets are efficient. The model uses variables like the current stock price, strike price, risk-free interest rate, time to maturity, and volatility to calculate a theoretical fair value price for the option. Traders can use option pricing models to evaluate an option's fair value and incorporate this into their trading strategies and portfolio adjustments.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd

    Black Scholes

    Uploaded by

    Aditi
    38 views3 pages
    The Black-Scholes model is a mathematical model for pricing options contracts based on certain assumptions. It assumes the option is European, there are no dividends or transaction costs, and that markets are efficient. The model uses variables like the current stock price, strike price, risk-free interest rate, time to maturity, and volatility to calculate a theoretical fair value price for the option. Traders can use option pricing models to evaluate an option's fair value and incorporate this into their trading strategies and portfolio adjustments.

    Original Title

    Black scholes

    Copyright

    © © All Rights Reserved

    Available Formats

    DOCX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    The Black-Scholes model is a mathematical model for pricing options contracts based on certain assumptions. It assumes the option is European, there are no dividends or transaction costs, and that markets are efficient. The model uses variables like the current stock price, strike price, risk-free interest rate, time to maturity, and volatility to calculate a theoretical fair value price for the option. Traders can use option pricing models to evaluate an option's fair value and incorporate this into their trading strategies and portfolio adjustments.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    38 views3 pages

    Black Scholes

    Uploaded by

    Aditi
    The Black-Scholes model is a mathematical model for pricing options contracts based on certain assumptions. It assumes the option is European, there are no dividends or transaction costs, and that markets are efficient. The model uses variables like the current stock price, strike price, risk-free interest rate, time to maturity, and volatility to calculate a theoretical fair value price for the option. Traders can use option pricing models to evaluate an option's fair value and incorporate this into their trading strategies and portfolio adjustments.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    The Black-Scholes model, also known as the Black-Scholes-Merton (BSM) model, is

    a mathematical model for pricing an options contract. In particular, the model


    estimates the variation over time of financial instruments.

    Black-Scholes Assumptions

    The Black-Scholes model makes certain assumptions:

     The option is European and can only be exercised at expiration.


     No dividends are paid out during the life of the option.
     Markets are efficient (i.e., market movements cannot be predicted)
     There is no limit on buying and selling of the underlying risky asset
     There are no transaction costs in buying the option.
     The risk-free rate and volatility of the underlying are known and constant.
     The returns on the underlying asset are log-normally distributed.

    Black-Scholes Formula

    where:

    where:
    C=Call option price
    S=Current stock (or other underlying) price
    K=Strike price
    r=Risk-free interest rate
    t=Time to maturity
    N=A normal distribution
    The first part, S*N(d1) is what you get i.e. the underlying stock if we decide to
    exercise our right to buy the stock.

    The second part, K*e(-rt)*N(d2) is what you have to pay to receive that option. Thus
    the exercise price, i.e. K is multiplied by the discounting factor e(-rt) as this is the
    amount which we could have invested in a riskless asset instead of buying the option.

    Option Pricing Models are mathematical models that use certain variables
    to calculate the theoretical value of an option. The theoretical value of an
    option is an estimate of what an option should be worth using all known
    inputs. In other words, option pricing models provide us a fair value of an
    option. Knowing the estimate of the fair value of an option, finance
    professionals could adjust their trading strategies and portfolios. Therefore,
    option pricing models are powerful tools for finance professionals involved
    in options trading.

    Option Pricing Models are mathematical models that estimates a value of


    an options contract by assigning a price, known as a premium, based on the
    calculated probability that the contract will finish in the money (ITM) at
    expiration
    IT provides an evaluation of an option's fair value, which traders incorporate
    into their strategies and in adjusting their portfolios

    The model use certain variables such as current market price, strike price,
    volatility, interest rate, and time to expiration to theoretically value an option.

    Some commonly used models to value options are Black-Scholes, binomial


    option pricing, and Monte-Carlo simulation.
    Following information is available for Co X’s shares and Call Options:
    Current Price (S)= $185 σ= 0.18
    Option Exercise Price (E)= $170 Risk Free Rate = 7%
    Time to expiry = 3 years

    Computing the Value of Option


    d1= {ln(S/E) + (r + σ 2 /2) t} / σ √t
    = {ln(185/170) + (0.07+ 0.182/2) 3}/0.18√3
    = (0.08452 + 0.2586)/0.18√3 = 0.34312/0.31177 = 1.1006
    Therefore, d1 = 1.1006
    d2 = d1 – σ √t
    =1.1006 – 0.31177 = 0.7888
    N(d1) = 0.8644 (from table)
    N (d2) = 0.7848
    Value of option = SN(d1) – N (d2). Ee-rt
    =185(0.8644) – 170/e 0.21 (0.7848)
    = 159.914 – 170/1.2336 * 0.7848
    =159.91-108.15 = $51.76

    You might also like