September 2012
Beginner
328 pages
7h 42m
English
Content preview from Key Financial Market Concepts, 2nd Edition
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The Black and Scholes Pricing Model
Definition
The Black and Scholes model is a formula for calculating option prices, named after Fischer Black and Myron Scholes, who developed it.
How is it used?
The pricing of an option depends on probability. In principle, ignoring bid/offer spreads, the premium paid by the buyer should represent his expected profit on exercising the option. The profit arises from the fact that he is always entitled to exercise an option which expires in-the-money and simultaneously cover himself in the market at a better price. The buyer will never be obliged to exercise the option at a loss to himself. As with insurance premiums, assuming that the option writer can accurately assess the probability of each possible outcome, ...
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