Black-Scholes Model

A mathematical formula used to estimate the fair price of an options contract.

The Black-Scholes model calculates a theoretical price for European-style options using the underlying asset's price, the strike price, time to expiration, volatility, and the risk-free interest rate. Developed in 1973, it remains a foundational tool in derivatives pricing, even though its assumptions of constant volatility and frictionless markets don't perfectly match reality.

The trading desk ran the option through the Black-Scholes model to check whether its market price looked cheap or expensive.