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.

Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.

Mentioned in

References in periodicals archive

Macbeth, 1982, "Further Results on the Constant Elasticity of Variance Call Option Pricing Model", Journal of Financial and Quantitative Analysis, 17:533-554

15020000 Tests of derivative pricing models

A 10-period trinomial call option pricing model is used to find the freely traded price of the ESO.

The Valrex model for valuing employee stock options. (Personal Financial Planning)

Because vesting requirements and the nontransferability of employee stock options reduce their value relative to freely traded stock options, the proposed accounting would require adjustments be made to the values provided by traditional option pricing models to compensate for these differences.

Accounting for stock-based compensation: the FASB's proposal

However, one important feature about the Black and Scholes option pricing model is that all its key factors are observable except volatility of the underlying asset.

Testing pricing efficiency of index options using Black-Scholes model: evidence from Indian index options market

Bezdek, "Numerical solutions for option pricing models including transaction costs and stochastic volatility," Acta Applicandae Mathematicae, vol.

Lookback option pricing with fixed proportional transaction costs under fractional Brownian motion

In this paper, we are interested in the option pricing model with transaction costs proposed by Barles and Soner [3] that are motivated by Hodges and Neuberger [4].

An unconditionally stable, positivity-preserving splitting scheme for nonlinear Black-Scholes equation with transaction costs

Duan, "The GARCH option pricing model," Mathematical Finance, vol.

Calibration of the volatility in option pricing using the total variation regularization

By relaxing some of the restrictive assumptions, such as the assumption of constant volatility and the geometric Brownian motion for the price of the underlying asset, many option pricing models have been proposed.

Pricing of American put option under a jump diffusion process with stochastic volatility in an incomplete market

The intent of developing this option pricing model is to find out which option will be viable and then to use these option prices as pay-offs in an incomplete game to find the Nash Equilibrium of such a game.

Psychological pricing in mergers & acquisitions using real options signalling games