What is the Black–Scholes model?

The Black-Scholes model is a price variation model used to determine the price of European-style options . It looks at the price change over time of investment instruments to deduce the Black-Scholes formula, which is then used to estimate the price of options.

Where have you heard about the Black–Scholes model?

If you've traded in the options market, you'll have heard of the Black-Scholes model - it's popular and widely-used by participants. It's one of the most important financial theoretical concepts, and one of the best ways to determine the fair price of options.

What you need to know about the Black–Scholes model.

The Black-Scholes model uses five variables to determine the formula: the strike price of an option, the current underlying price, the time until expiration, the annualised risk-free rate and the implied volatility.

While the model is generally seen as productive in determining options prices, it does have some drawbacks, including the fact that it only works with European-style options. It also takes the volatility and risk-free rates as constants, something that cannot be assumed in reality. Nevertheless, the model is used widely because it provides a useful approximation of options prices.