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Black-Scholes Model
Practical Law Glossary Item 6-595-4165 (Approx. 2 pages)
Glossary
Black-Scholes Model
A method for calculating the value of financial instruments that can be used to determine what the price of a stock option should be. Developed by Fisher Black, Robert Merton and Myron Scholes, the model is widely regarded as one of the best ways to determine the fair price of an option. The model uses several inputs when calculating an option's value, including:
- The current price of the underlying stock.
- The option exercise price.
- The amount of time until the option expires.
- Volatility or rate of change in the price of the underlying stock.
- Risk-free interest rates.
The Black-Scholes Model is geared toward European options that can only be exercised on the expiration date, as opposed to American options, which, once vested, can be exercised at any time up to and including the expiration date. Nonetheless, studies show that the model is very predictive, if not 100% accurate. While the mathematics of the formula are complicated, online calculators have been developed which can be used to perform the necessary calculations and determine an appropriate value. There are many variations of the Black-Scholes Model.