Option Pricing Model

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.

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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.