Black-Scholes formula

The Black-Scholes formula is a mathematical model used to determine the theoretical price of options. Developed by Fischer Black and Myron Scholes, it revolutionized options trading by providing a benchmark for valuation. The formula considers factors such as the underlying asset's price, strike price, time to expiration, interest rates, and volatility.12

Before this formula, investors lacked a reliable way to value options. The Black-Scholes model demonstrated that a combination of shares and call options could create a riskless portfolio, a concept widely adopted by traders. Robert Merton later expanded upon the formula to apply to other financial areas, including mortgages and risk management. The model's inputs are measured by "the greeks" (delta, gamma, theta, vega, and rho), which help traders understand how an option's price might change.12