1. Options Pricing: Introduction
  2. Options Pricing: A Review Of Basic Terms
  3. Options Pricing: The Basics Of Pricing
  4. Options Pricing: Intrinsic Value And Time Value
  5. Options Pricing: Factors That Influence Option Price
  6. Options Pricing: Distinguishing Between Option Premiums And Theoretical Value
  7. Options Pricing: Modeling
  8. Options Pricing: Black-Scholes Model
  9. Options Pricing: Cox-Rubinstein Binomial Option Pricing Model
  10. Options Pricing: Put/Call Parity
  11. Options Pricing: Profit And Loss Diagrams
  12. Options Pricing: The Greeks
  13. Options Pricing: Conclusion

Option traders use various option pricing models to calculate theoretical option values. These mathematical models use certain fixed knowns in the present – things like underlying price, strike price and days until expiration – along with forecasts (or assumptions) for factors such as implied volatility, to compute the theoretical value for specific options at certain points in time. Variables fluctuate over the life of the option, and the option's theoretical value adapts to reflect these changes.

Most professional traders and investors who trade large option positions rely on theoretical value updates to monitor the changing risk and value of their option positions, and assist with trading decisions. Many options trading platforms provide up-to-the-minute option price modeling values, and option pricing calculators can be found online at various websites, including the Options Industry Council. The basic calculator shown in Figure 3 lets you choose the model/exercise type, and then prompts you to enter various fields, including the contract type, spot price of the underlying, expiration date, interest rate, dividend amount (if applicable) and strike price.

Basic options calculator
Figure 3 The options calculator from the Options Industry Council lets you choose either a Binomial model (for American style options) or the Black-Scholes model (for European options).

Options Pricing: Black-Scholes Model
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