Scholes Option Pricing

The Scholes option pricing model is based on the Black Scholes method. Myron Scholes was part of the team that came up with this particular option pricing model. The Scholes option pricing model wasn't developed out of thin air, however, and was actually based on the Boness option pricing model. The Scholes Option Pricing model improved upon the Boness model, however, and made it considerably more accurate. As a result, the Scholes option pricing model is very popular with traders because it most accurately predicts option prices.

Background of the Scholes Option Pricing Model

The Scholes Pricing Model, as previously stated, enhanced the Boness Model. Many traders assume the Black Scholes Option Pricing Model was developed solely by these two individuals. However, that is not completely accurate because without the Boness Model it is possible the Scholes Option Pricing Model may not have turned out as accurate as it did.

Scholes Option Pricing Model Enhanced the Boness Model

There were several changes made to the Boness Model to create the Black Scholes Option Pricing Model. One of them was to substitute the discount factor for the risk free interest rate. Also, the investors' risk preference assumption was eliminated. By making these changes to the Boness model the Scholes Option Pricing Model became significantly more accurate and a better aid for traders.

Scholes Option Pricing Model Assumptions

For the Scholes option pricing model to be accurate it must assume no dividends will be paid over the life of the option. In order to balance out the assumption and its limitations the stock price subtracts the future dividend discounted price. The adjustment in the pricing model counteracts the limitation that lower call premiums may cause higher dividend yields.

Efficient Markets and the Scholes Option Pricing Model

The Scholes Option Pricing Model also assumes that it is impossible to consistently predict the market as a whole due to the fact that share prices are on a never enduing scale.

Interest and Commission in the Scholes Option Pricing Model

The Scholes Option Pricing Model does not include any commissions in an attempt to keep values as accurate as possible. Consistency is important in the Scholes Option Pricing model and including commissions could affect values significantly. The mathematical Scholes Option Pricing Model also uses the risk free interest rate. There is no actual "risk free interest rate" however the US Government Treasury Bill's discount rate at 30 days to maturity fills in for this.