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 ... 
Black's Model
A variation of the popular BlackScholes options pricing model ... 
Trinomial Option Pricing Model
An option pricing model incorporating three possible values that ... 
Model Risk
A type of risk that occurs when a financial model used to measure ... 
Down Transition Probability
The probability that an asset's value will decline in one period's ...

Trading
Breaking Down The Binomial Model To Value An Option
Find out how to carve your way into this valuation model niche. 
Trading
The "True" Cost Of Stock Options
Perhaps the real cost of employee stock options is already accounted for in the expense of buyback programs. 
Trading
Options Pricing: BlackScholes Model
The BlackScholes model for calculating the premium of an option was introduced in 1973 in a paper entitled, "The Pricing of Options and Corporate Liabilities" published in the Journal of Political ... 
Trading
Circumvent Limitations of BlackScholes Model
Mathematical or quantitative modelbased trading continues to gain momentum, despite major failures like the financial crisis of 200809, which was attributed to the flawed use of trading models. ... 
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
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 ... 
Investing
The Controversy Over Option Expensing
There has been much debate over whether companies should treat employee stocks options as an expense. This article examines both sides of the argument.

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