The Black-Scholes Formula - Home Flathead Valley …布莱克-斯科尔斯公式-家居的平头谷….docVIP

The Black-Scholes Formula By Gretchen Browne Abstract: The mechanics and use of European put and call options are explained. Using the no arbitrage assumption as a basis for understanding, the derivation of the Black-Scholes formula for option pricing is explained. The relationship to the heat equation of physics is shown. An example is given of option pricing using the formula. Most of us are familiar with traditional investments such as stocks, bonds or mutual funds. Relatively recently, a new investment class has arisen. These new securities are priced according to the value of an underlying asset. The underlying asset may be any of number of things. Some possibilities include stocks, bonds, interest rates, and currency values among many others. Since the value of the contract depends upon the value of the underlying asset, the contract is considered to derive its value from that asset. Hence, these contracts are often called “derivatives.” This paper shall focus on a specific type of derivative known as a European put or call option, with the underlying security being a stock. Options are contracts giving the holder, or purchaser, of the contract “the right to buy or sell an underlying asset at a fixed price.” (Chriss) While the holder has the right to buy or sell the underlying asset, he or she is not obligated to do so. The fixed price at which the asset may be purchased or sold is known as the strike price or exercise price. The right to buy the underlying security is known as holding a call option. The right to sell the underlying security for the exercise price is called a put option. If the holder of the option chooses to buy or sell the underlying asset, he is said to “exercise the option.” European call options may only be exercised on a set date, known as the expiration date. This date may also be simply termed “expiry.” Naturally, having the right to buy or sell the underlying asset means someone must be selling the right to buy or