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Trends & Analysis
News

USD gains amid Fed rate cut speculations

News

Is the silver squeeze back?

News

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News

Gold closes week higher on rate cut speculations

News

Week Ahead Preview: 20th of May

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Walmart’s stock hits record high on Q1 results

Black Scholes model definition

Black Scholes model definition

The Black Scholes model is a mathematical model used to price options contracts in financial markets. It is widely used by traders and investors to value options and to make trading decisions based on an option’s price and an asset’s implied volatility. It was developed in 1973 by Fischer Black and Myron Scholes, and the model works on the assumption that investors are rational and risk averse.

 

How does the Black Scholes model work?

The Black Scholes model considers several factors. They include the underlying asset price, the option’s strike price, the time until the contract’s expiry date, the risk-free interest rate, and the implied volatility of the underlying asset. With these factors, the model calculates the theoretical value of the option. Traders can then compare this value to the option’s market price to determine whether it is overpriced or underpriced.

 

An example of using the Black Scholes model

A trader believes that the stock price of a company will increase in the next four months. The stock is currently trading at $100. The trader decides to buy a call option on the stock with a strike price of $110 for a premium of $5 per share. Having purchased the call option, the trader has the right to buy the stock at the strike price of $110 anytime within the next four months.

The trader can use the Black Scholes model to calculate the fair value of the option. They take into consideration these factors: the current stock price is $100, the contract expires in four months, the volatility of the stock is 30%, and the risk-free interest rate is 2%, and the premium is $5 per share.

With the Black Scholes model, the trader discovers that the fair value of the option is $3.51 per share. If they believe that the option is overvalued, they may sell it and profit from the difference between the market price and the fair value calculated by the model. Conversely, if they believe the option is undervalued, they may purchase it in anticipation of the stock price appreciating.

 

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ADSS offers a range of global markets for traders, with opportunities in indices, commodities, forex, equities and more. We also feature tutorials, how-to guides, and weekly webinars to help you navigate the financial markets and find better trading opportunities. You can start trading and investing online by opening a live trading or demo trading account.

 

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