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BLACK-SCHOLES FORMULA
The Black-Scholes equation was developed to place a theoretical value on stock options during the time period before they reach the exercise date. This theoretical or intrinsic value of the option may differ from what you paid for the option. And this value would certainly change daily as the time period declines and the market price fluctuates daily.
The following variables are important in the Black-Scholes model:
- strike price
- time period
- volatility
The Black-Scholes model has strengths and weaknesses:
| Strengths | Weakness |
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Equation
The Black-Scholes equation for the fair value of a European call option* on a non-dividend paying stock is:
* A European call option can only be exercised on its expiration date. This is in contrast to American options that can be exercised at any time prior to expiration.
Memory Jogger
What’s the difference between European and American options?