DEFINITION of 'Option Pricing Theory'
Any model or theorybased approach for calculating the fair value of an option.
The most commonly used models today are the BlackScholes model and the binomial model. Both theories on options pricing have wide margins for error because their values are derived from other assets, usually the price of a company's common stock. Time also plays a large role in option pricing theory, because calculations involve time periods of several years and more. Marketable options require different valuation methods than nonmarketable ones, such as those given to company employees.
BREAKING DOWN 'Option Pricing Theory'
How stock options should be valued has become an important debate in the past few years because U.S. companies are now required to expense the cost of employee stock options on their earnings statements. For many young companies trading on the stock exchanges today, this expense will be considerable no matter what valuation methods are used. The need for consistent and accurate treatment of this increasing expense provides incentive for the creation of new and innovative solutions to option pricing theory.

Binomial Option Pricing Model
An options valuation method developed by Cox, et al, in 1979. ... 
LatticeBased Model
An option pricing model that involves the construction of a binomial ... 
BjerksundStensland Model
A closedform option pricing model used to calculate the price ... 
Implied Volatility  IV
The estimated volatility of a security's price. 
Versioning
A business practice in which a company produces different models ... 
Relative Valuation Model
A business valuation method that compares a firm's value to that ...

Trading
Breaking Down The Binomial Model To Value An Option
Find out how to carve your way into this valuation model niche. 
Investing
ESOs: Using the Binomial Model
By David Harper On April 1, 2004, the Financial Accounting Standards Board (FASB) published a proposal on the new accounting treatment of employee stock options ESOs. The final rules will probably ... 
Trading
How To Build Valuation Models Like BlackScholes (BS)?
Want to build a model like BlackScholes? Here are the tips and guidelines for developing a framework with the example of the BlackScholes model. 
Trading
Options Pricing: Modeling
Option traders utilize various option price models to attempt to set a current theoretical value. Models use certain fixed knowns in the present – factors such as underlying price, strike ... 
Trading
Should Employees Be Compensated With Stock Options?
Learn the good, the bad and the ugly sides of this type of payout. 
Trading
The Anatomy of Options
Find out how you can use the "Greeks" to guide your options trading strategy and help balance your portfolio. 
Investing
Examples To Understand The Binomial Option Pricing Model
Binomial option pricing model, based on risk neutral valuation, offers a unique alternative to BlackScholes. Here are detailed examples with calculations using Binomial model and explanation ... 
Trading
Understanding the BlackScholes Model
The BlackScholes model is a mathematical model of a financial market. From it, the BlackScholes formula was derived. The introduction of the formula in 1973 by three economists led to rapid ... 
Trading
Stock Options: What's Price Got To Do With It?
A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price. 
Investing
ESOs: Using the BlackScholes Model
Companies need to use an optionspricing model in order to "expense" the fair value of their employee stock options (ESOs). Here we show how companies produce these estimates under the rules ...

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