option pricing model

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Option Pricing Model

Any formula or theory for mathematically determining the correct price for an option contract. An option pricing model may take into account the strike price, the time until the expiration date, the price of the underlying asset, and the standard deviation of the underlying asset's return. The time until the expiration and the price of the underlying asset are particularly important. Option pricing models have a large margin of error because the price of the underlying asset or other factors may change over the life of the contract. Most option pricing models also operate under certain assumptions that may affect their accuracy. The most common option pricing models are the Black-Scholes option-pricing model and the binomial model.

option pricing model

A mathematical formula for determining the price at which an option should trade. The model expresses the value of an option as a function of the value of the underlying asset, length of time until maturity, exercise price, yields on alternative investments, and risk. See also Black and Scholes Model.
References in periodicals archive ?
Bezdek, "Numerical solutions for option pricing models including transaction costs and stochastic volatility," Acta Applicandae Mathematicae, vol.
Our experience, which includes working with over 1,500 companies over a period of 31 years, indicates that traditional option pricing models tend to overstate the value of employee options.
This article explains real options analysis and valuation theories as they apply to real estate, including financial option pricing models, the Black Scholes-Merton model, real options analysis, binomial options models, and Monte Carlo simulation.
Subjects include: derivative markets and instruments, options market structures, option pricing models and strategies, the structure of forward and futures markets, futures arbitrage strategies, swaps, financial risk management techniques and applications, and managing risk in organizations.
Chen, 1997, "Empirical Performance of Alternative Option Pricing Models," Journal of Finance 52, 2003-2049.
In section 2, the assumptions, the option pricing models and the methods used to calculate the inputs are outlined.
Nonparametric Tests of Alternative Option Pricing Models Using All Reported Trades and Quotes on the 30 Most Active CBOE Option Classes from August 23, 1976 Through August 31, 1978," Journal of Finance 40(2), 455-480.
The final approach, contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics.
Thus, the company often will use the binomial or Black Scholes option pricing models to value these warrants.
Although more appropriate for measuring company cost than executive value, standard option pricing models rely on assumptions that clearly do not apply--that options are tradable or hedgeable in markets.
We also considered conducting various option-based tests on our volatility forecasts, including tests for pricing/hedging effectiveness, but did not do so because pricing/hedging effectiveness testing cannot be legitimately undertaken on the volume-ARCH-option combinations we study given the menu of option pricing models currently in existence.