TABLE OF CONTENTS This appendix is an introduction to the Black-Scholes stock options model. This model is used to determine the most probable value of a stock option based on volatility and time until expiration. It was developed by Fischer Black and Myron Scholes and has become the industry standard. This discussion is for educational purposes and academic interest only, and the reader should never invest in the options market unless he/she understands the risks involved. It is not an infallible guide in making investment decisions. A guidance from an experienced stock broker is always a must.
There are two kinds of options. The first is known as a call option which is an option to buy. When we purchase a call option, we obtain the right to buy a specified number of shares of a security (common stock), treasury bonds, or commodity futures [*] at some point within a specified time period at a fixed price, regardless of price changes within the specified time period. [ ] This fixed price is referred to as the exercise price, or strike price.
Presently common stock of the XYZ Corporation trades at $100 a share. Our stock broker tells us that we can buy shares of this stock at $105 a share at any time in the next 100 days, and for this buying option the brokerage house charges us a premium of $5 per share. Suppose that we buy 200 shares and at some time within...
