Next video:
Loading the player...

The Black-Scholes model is a mathematical model of a financial market. From it, the Black-Scholes formula was derived. The introduction of the formula in 1973 by three economists led to rapid growth in options trading.

This formula is widely used in global financial markets by traders and investors to calculate the theoretical price of European options, a type of financial security. These options can only be exercised at expiration.

The formula has been demonstrated to yield prices very close to the observed market prices.

The Black-Scholes formula requires complex mathematics. Fortunately, traders and investors who use it do not need to do the math. They can simply plug the required inputs into a financial calculator.

The necessary inputs are:

- the underlying stock's price

- the option's strike price

- time to the option's expiry

- volatility of the stock

- time value of money (or risk free interest rate)

The Black-Scholes model does not take into account dividends paid during the life of the option.

The model is also known as the Black-Scholes-Merton Model. Black, Scholes and Merton were the economists who introduced the mathematical model in 1973. Although Black’s death in 1995 excluded him from the award, Scholes and Merton won the 1997 Nobel Prize in Economics for their work.

Related Articles
  1. Trading

    Circumventing the Limitations of Black-Scholes

    Learn the ways to get around the flaws in trading models like Black-Scholes.
  2. Investing

    The Volatility Surface Explained

    Learn about stock options and the "volatility surface," and discover why it is an important concept in stock options pricing and trading.
  3. Trading

    Understanding How Dividends Affect Option Prices

    Learn how the distribution of dividends on stocks impacts the price of call and put options, and understand how the ex-dividend date affects options.
  4. Trading

    Breaking Down The Binomial Model To Value An Option

    Find out how to carve your way into this valuation model niche.
  5. Trading

    Dividends, Interest Rates and Their Effect on Stock Options

    Learn how analyzing dividends and interest rates is crucial to knowing when to exercise early.
  6. Trading

    The Anatomy of Options

    Find out how you can use the "Greeks" to guide your options trading strategy and help balance your portfolio.
Trading Center