2. Fundamentals of Option Pricing

When equity options began trading on the Chicago Board Options Exchange in April 1973, no accepted pricing methodology existed. As a result, traders relied on a variety of approaches largely based on anecdotes and rules of thumb gleaned from personal experience. The situation was not entirely new, however, because small volumes of equity options had been trading over the counter for many years.

In 1973 a landmark paper published by Fischer Black and Myron Scholes in the Journal of Political Economy revolutionized the world of derivatives pricing with a rigorous and extensible mathematical framework. The paper proposed a new model that quantified the influence and interaction of both time and uncertainty. This ...

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