Black Scholes option-pricing model

Definition

Formula for estimating the value of European (exercisable only on the expiration date) call options, primarily for equities. It incorporates factors such as underlying stock's price volatility, the relationship of its current price to the option's exercise price, expected dividends, expected interest rates, and option's time to expiration. The assumptions it is based on include: (1) no dividend is paid during the option's life, (2) trading in the option and in its underlying stock occurs simultaneously, (3) no brokerage commissions are charged, (4) borrowing and lending takes place at the same interest rate, (5) market is efficient (information about stock prices is available instantly and to all participants), (6) price of the underlying stock smoothly increases or decreases, without any discontinuous jumps, (7) transaction costs are zero or negligible. The complex algorithm of this model was developed by the US mathematicians Fischer Black and Myron Scholes in 1973, and later modified by Robert Martin. After the death of Black in 1995, this model earned Scholes and Martin the 1997 Nobel prize in economics. The algorithm has continuously been improved upon by researchers such as Barone Adesi & Whaley, Garman Kohlhagen, and Cox, Ross, & Rubinstein. Called also Black-Scholes-Martin model.