The Black–Scholes or Black–Scholes–Merton model is a mathematical model used to estimate the price of European Style derivatives, including options contracts. The model forms the basis of the Black-Scholes formula, which can be rewritten in different forms to solve for various options trading parameters. Black-Scholes led to a boom in options trading. Black-Scholes is widely used in options trading, often with adjustments and corrections. The estimations of the Black-Scholes model has multiple times been proven to be close to the observed options prices. Many factors affect how close the model is to actual prices, including market efficiency and options liquidity.
OptionAutomator's Brutus Options Screener uses modified Black-Scholes models extensively to quantify various options parameters to provide the best options trades against your criteria.
The Risk-free interest rate is the return on investment with no loss-of-capital risk. In practice, this does not exist. In theory, it is an important parameter in option pricing as it sets the baseline price upon which risk premium should be added. A practical estimate to the risk-free interest rate is taken from 'risk-free' bond issued by the government or agency where the default risk is practically zero.
The minimum expected return by an investor from risk free financial investments like treasury bills. This rate is considered when comparing alternate strategies and products to assess the incremental return potential associated with the additional risk in the position. [click to read more]