Black Scholes Model

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DEFINITION of 'Black Scholes Model'

A model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. The model assumes that the price of heavily traded assets follow a geometric Brownian motion with constant drift and volatility. When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option's strike price and the time to the option's expiry.

Also known as the Black-Scholes-Merton Model.

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BREAKING DOWN 'Black Scholes Model'

The Black Scholes Model is one of the most important concepts in modern financial theory. It was developed in 1973 by Fisher Black, Robert Merton and Myron Scholes and is still widely used today, and regarded as one of the best ways of determining fair prices of options.

There are a number of variants of the original Black-Scholes model.

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RELATED FAQS
  1. How is implied volatility for options impacted by a bearish market?

    Implied volatility for options increases during a bearish market. A bearish market is considered to have more risk than a ... Read Full Answer >>
  2. Can pro forma financial statements be more helpful to analysts and investors than ...

    Although there are inherent problems with investors relying on either the pro forma financial statements issued by companies ... Read Full Answer >>
  3. How is implied volatility used in the Black-Scholes formula?

    Implied volatility is derived from the Black-Scholes formula and is an important element for how the value of options are ... Read Full Answer >>
  4. What is a "non linear" exposure in Value at Risk (VaR)?

    The value at risk (VaR) is a statistical risk management technique that determines the amount of financial risk associated ... Read Full Answer >>
  5. What technical skills must one possess to trade options?

    An option is a financial derivative that gives you (as the buyer or holder) the right to buy or sell an underlying security ... Read Full Answer >>
  6. What is an option's implied volatility and how is it calculated?

    Implied volatility is a parameter part of an option pricing model, such as the Black-Scholes model, that gives the market ... Read Full Answer >>

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