Black–Scholes model

How can you predict the price of an option?

Imagine you're betting on a soccer match and want to know how much to bet on your favorite team winning.

Think of the soccer match as a financial option. The Black-Scholes-Merton model helps you figure out how much to bet by considering the team's current performance (stock price), the odds (strike price), the time left in the season (time to expiration), and the chances of winning (volatility). It's like a formula that gives you the best bet based on these factors.

Example

Your favorite team is currently performing well (stock price), the odds are favorable (strike price), there's still a few months left in the season (time to expiration), and they've been unpredictable (volatility). Using the Black-Scholes-Merton model, you can calculate the best bet to place.

Remember this

The Black-Scholes-Merton model helps you determine the best bet on an option by considering the team's performance, odds, time left, and unpredictability.

Text adapted from Wikipedia, licensed under CC BY-SA 4.0.

Related concepts

Real options valuation

Why can't we always predict the future in business?

the Black-Scholes formula prices

How do you price a gamble on a stock's future price?

Lattice model (finance)

How can you price an option that doesn't expire?

the Black-Scholes assumptions are

Why can’t we always predict stock prices perfectly?

Greeks (finance)

Greeks measure sensitivity of option prices to underlying parameters

implied volatility tells you

Ever wondered how traders predict stock swings?

Educational content, not financial advice.

Swipe through 100 ML concepts daily

Open Pocket Polymath