Option Pricing Black Scholes

The option pricing Black Scholes method was developed by Myron Scholes and Fischer Black. The option pricing Black Scholes model is incredibly accurate and widely used by traders to predict option prices.

Option Pricing Black Scholes History

The history behind the option pricing Black Scholes model is that it was based on a model originally developed by A. James Boness. However, the Boness model was not completely accurate and while it had a good start it had some significant faults. With some reworking by Black and Scholes the Boness model was improved enough to become the option pricing Black Scholes model that became incredibly popular based on its accuracy.

Changes Made to Create Option Pricing Black Scholes

The changes that were made to the Boness model include the use of the discount factor as the risk free interest rate as well as eliminating the assumption that related to the risk preferences by investors. These changes alone increased the accuracy of the option pricing Black Scholes model significantly.

Assumption of the Option Pricing Black Scholes Model

The major assumption of the option pricing Black Scholes model is that over the option's life no dividends are paid. The discounted price of the future dividend is subtracted from the stock price to adjust the assumption and its limitations. A basic limitation is that higher dividend yields may result from lower call premiums, however the adjustment makes up for this.

Option Pricing Black Scholes Efficient Market Assumption

The option pricing Black Scholes model has another assumption that individual stocks or the market as a whole cannot be predicted consistently. This is based on the assumption that share prices are on a continuum that has no end.

Option Pricing Black Scholes Assumption of No Commission and Interest Rates

Including commissions in the Black Scholes model can distort the values. Because of this no commissions are assumed in order to keep the model accurate and consistent. Also, even though no risk free rate actually exists, it is used in this mathematical model. The way it is used is because the discount rate on the Us Government Treasury Bill, with 30 days to maturity, fills in for the risk free rate.