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.